Is a mortgage refinance right for you? Interest rates are currently hovering at a historic low, making swapping out your old higher rates for these new ones an appealing choice. In January of this year, the Mortgage Bankers Association’s Refinance Index reported activity up a whopping 78% from 2019.
But before you rush to fill out the refinance portion of your mortgage application, you need to look beyond just the current mortgage interest rates. Consider asking yourself these seven questions before you decide to refinance.
Why Do I Want to Refinance?
You could have a few different reasons for wanting to refinance your mortgage.
Lower Your Interest Rate
The most popular reason for deciding to refinance your mortgage is to lower your interest rate. If your current interest rate is higher than current mortgage interest rates, locking in a new rate could leave you with considerable savings that could really make a difference in the long run. Remember that if you lock in a lower rate for a longer amount of time, you could still end up paying the same amount (or more) than if you had kept a higher rate for a shorter period of time.
Eliminate Private Mortgage Insurance
Is your home currently financed by the Federal Housing Administration (FHA)? This probably means you’re paying for mandatory private mortgage insurance (PMI), which adds up. If you are able to refinance your home under a conventional mortgage instead of an FHA mortgage, you will be able to eliminate your PMI and lower your monthly costs.
Switch From an Adjustable Rate Mortgage to a Fixed Rate Mortgage
Another reason you may want to consider refinancing your mortgage is if you currently have an adjustable rate mortgage (ARM) and want to switch it to a fixed rate mortgage (FRM). This might be a smart idea if you currently have low interest rates and feel confident the market interest rates won’t be continuing to decrease in the future. An FRM can freeze your ideal rate and give you the best savings in the long run.
How Is My Credit?
You’ll want to be familiar with your credit score before applying to refinance your mortgage. Similar to applying for a credit card or to renting or purchasing a home, your credit score is going to be under scrutinization.
Even if you think your credit score is fine, lenders might not agree. Although you might have average credit, you may not qualify for the lowest interest rates, which is something you need to take into consideration. In general, you will need a score of 620 or higher to qualify for a traditional refinance, but with a higher score, your lender may be more willing to work with you on closing costs and interest rates.
Have bad credit? Don’t be discouraged. You still have options for refinance, such as speaking to your current lender about keeping your business and refinancing through them, or applying for a Federal Housing Administration (FHA) refinance option.
How Much Equity Do I Have in My Home?
Home equity is the current market value of your home, minus what you owe. Positive home equity can be achieved through making payments on your principal balance, or if the housing market value increases. Online home equity calculators or in-person home appraisals can help you figure out your home equity. The higher the equity, the easier it will be for a lender to approve a refinancing loan since they see that you have a major stake in your home, and aren’t likely to default on payments.
Can I Afford the Closing Costs?
Asking yourself if you can afford to refinance may seem obvious, but you need to consider all costs involved with refinancing. Fees such as mortgage refinance closing costs are typically 1% to 3% of your total loan amount. The most cost-effective way to take care of closing costs is to pay them out of pocket, since if you decide to finance your closing cost, you’re going to end up paying close to double the initial amount with interest over time. You can also decide to absorb the closing cost into your total refinancing loan, which may or may not increase your interest rates.
What Is My Debt-to-Income Ratio?
In addition to your credit score, lenders will also be looking at your debt-to-income ratio (DTI) when weighing your refinance application. Your DTI is your monthly debt payments compared with your gross monthly income. To find out your DTI, divide your monthly payments by your monthly income. Lenders look at your DTI to find out whether or not you’ll be able to afford to make your payments month after month.
The lower the DTI, the better. Reduce your DTI by avoiding new lines of credit, considering debt consolidation, paying off your credit cards and other loans, and looking into how to increase your income.
What Are the Terms of My Current Mortgage?
Many mortgage contracts require the borrower to stick with their original mortgage for a minimum of one year before refinancing. Check with your current lender to go over the terms of your original mortgage contract to make sure you are within your rights to refinance. Refinancing with your original lender is oftentimes easier and more convenient — eliminating the need for new property appraisals, etc. — and you can often achieve a better rate this way.
How Long Do I Plan on Living Here?
Refinancing your mortgage will be the most beneficial if you’re planning on living in your home for a significant amount of time. Since the first few years of paying off a mortgage are mostly paying interest, refinancing every few years or planning on moving in a short period won’t do much to decrease your balance. Only plan on refinancing your mortgage if you plan on staying in your home for a considerable amount of time so you can achieve the benefit of amortization and be able to make actual progress on paying off your mortgage.
Before you make your decision to refinance your mortgage, make sure you do the research. Ask yourself these questions and more to evaluate your refinancing options and make the right choice. And if you need a little extra help, Seattle Mortgage Planners is here to provide expert advice and guidance during your journey toward refinancing your home. Send us a message or schedule a call with us today to get started!