Refinancing a mortgage isn’t as easy as it used to be, especially since the housing bubble burst in 2008. Of course that doesn’t mean you should rule it out. Refinancing can make financial sense, but you should consider these factors before trying to refinance your mortgage.
In order to avoid private mortgage insurance (PMI), your home needs to have a minimum of 20 percent equity. The cost of PMI could negate the potential advantages of a refinance. However, even if you have little equity or owe more on your home than it’s worth, you could benefit from some mortgage programs. A reputable lender will find the right fit for you, but you should make sure you exceed financing qualification guidelines. It would also help if you could pay down your loan balance at the time of settlement.
Don’t let yourself get reeled in by announcements of low loan rates on the news and in commercials. Those only apply to the most qualified clients. If your score falls below 620, most likely you won’t qualify for a refinance at all. Lenders typically give the lower rates to buyers with scores higher than 720. For rates in between, a sliding scale applies. The lower the credit score, the higher your interest rate will be.
Terms of Loan
Whether a new loan makes sense depends on its terms. If you have an adjustable rate mortgage (ARM), consider the advantages of a fixed-rate loan. This especially applies if you have a subprime rate. However, stick with a conventional ARM because rates could actually drop. Also, if you’re moving within a year, hold off on refinancing. The same applies if your existing mortgage has a prepayment penalty.
Refinancing makes sense if you can lower your monthly payments. If your goal is to switch to a shorter term loan in order to pay off your debt earlier and to reduce interest, take into consideration that this most likely will increase your payment. This can create problems when employment concerns arise but might make sense if your career is on the upswing.
If you carry a second mortgage, your refinancing process will become more complex. You can either combine the two mortgages into one, or pay off the second debt. Otherwise, the note holder of the second loan has to agree to let the lender of the first mortgage stay in first position. Lenders might not want to agree to that.
It takes time to see financial benefits of a refinance because of the settlement expenses. Expect the cost to run between 3 to 6 percent of the new amount. Use a loan calculator to see how long it would take to reach the break-even point. For example, if it takes 15 months of payments to catch up on the difference and you plan to stay in the residence for at least five years, the cost of a refinance would be beneficial.
While excellent income, credit and home value make up the trifecta cornerstone of the qualification process, don’t disregard the other factors. If you know you are not meeting some requirements, use this information to improve your circumstances for the future.