Top 6 Factors to Consider When Deciding to Refinance Your Home

With mortgage rates skyrocketing over the last year, many people stopped looking into refinancing their mortgages. While interest rates aren’t the only factor to consider when deciding if you should refinance, they play a big role. Here’s the good news – interest rates are predicted to fall into the 6% or potentially 5% range, which is definitely when many people should consider refinancing.

So, what should you consider when deciding if refinancing is right?

Keep reading to learn more.

6 Factors to Consider When Refinancing

Here’s what to consider when deciding whether you should refinance.

1.    Interest Rates

Of course, the driving factor to refinance is to save money. If you can get a lower interest rate, why not refinance?

Before jumping on board, determine how much you can save. For example, if you have a $200,000 mortgage with a 7% rate, you pay $1,330 in principal and interest. But if you can get a lower rate of 6%, you’d lower your payment to $1,199, a savings of $131 per month or $1,572 per year.

2.    Break-Even Point

When you refinance, you pay closing costs again. Consider your break-even point to determine if it makes sense to refinance your mortgage. This is the point that you pay off the closing costs and can enjoy the monthly savings.

Using our above example, let’s say refinancing costs $3,500. It would take 27 months to pay off the closing costs with the monthly savings. Refinancing makes sense if you plan to be in the home for much longer than 27 months. If you have plans to move shortly after or before 27 months, save your money and keep your current mortgage.

3.    Time Left on Your Loan Term

Refinancing restarts your mortgage term. If you only have a little time left, it may not make sense to refinance. If you want to take advantage of lower rates, consider shortening your term. For example, if you have 10 years left on your loan but want a lower rate, refinance into a 10-year term, not a 30-year term.

Not only will you lower your interest costs, but you’ll probably get an even lower interest rate because of the shorter term.

4.    Your Credit Score

To get the best interest rates, you need good credit. If your credit score has struggled lately, consider waiting to improve it. The good news is that credit scores change monthly based on your most recent activity.

If your credit score needs improvement, consider ensuring all payments are made on time, decrease your outstanding debt, and don’t apply for new credit.

5.    The Reason for Refinancing

Lower interest rates are a big reason to refinance, but they aren’t the only reason. Some other common reasons homeowners consider it include:

• Accessing cash from their home’s equity (cash-out refinance)
• Shortening the loan term to get a lower payment
• Getting better rates or terms because their credit improved
• Refinancing out of an adjustable-rate loan

6.    Your Existing Debt

Your debt-to-income ratio is essential in a mortgage approval, even when refinancing. Lenders must ensure you can cover the cost of the mortgage plus your existing debts without any trouble.

Consider paying some debts down before applying to refinance. The lower your debt-to-income ratio is, the easier it is to qualify for the best interest rates.

How Does Refinancing Work?

Refinancing your mortgage means paying off your existing mortgage and replacing it with a new mortgage. Essentially, you start from scratch, but as we discussed above, you can choose a term that matches the time left on your current mortgage.

Like when you bought your home and took out a mortgage, there are some crucial steps to take:

• Shop around for the right lender

No two lenders have the same programs, terms, or rates available. Consider shopping around with several lenders to determine the best program available based on your qualifying criteria.

• Get pre-approved

After choosing a few lenders, get pre-approved. This tells you how much they’ll lend you and on what terms. This helps narrow your choices and determine which lender has the most attractive terms, making refinancing worth it.

• Lock your rate

After choosing a lender, lock in your interest rate and gather any necessary documentation to clear the underwriting conditions. This includes paystubs, W-2s, tax returns, and asset documents, in some cases.

• Get an appraisal

Most lenders require an appraisal to ensure your home is worth enough to cover the loan’s collateral. You’ll pay out-of-pocket for the appraisal, and it’s only good for the chosen lender, so do this step once you’ve finalized your lender and loan program.

• Close the loan

The final step is to close the loan. You’ll have a closing, like when you bought the home, but without sellers or attorneys present. You’ll sign documentation taking ownership of the new mortgage and paying off the existing loan.

You’ll also bring any money to the table required to cover the closing costs or any money you’re putting toward the mortgage to keep the payment low.

Final Thoughts

Refinancing your mortgage can help you save money, especially with the lower interest rate environment we may see in the coming months or years.

The key is to look at the big picture to determine when it makes sense to refinance. Don’t refinance just because you want to say you have a 6% rate versus 7%. To ensure it makes sense, consider the savings, closing costs, and how long you intend to be in the home.

It’s important to emphasize your credit score and ensure you have the best score possible to get low rates. The better the qualifying factors you can provide a lender, the better rates and terms will be available for your refinance.

Want to learn even more about home refinancing, click here to see what NerdWallet has to say. Additionally, this Experian article goes into the importance of shopping around during the refi process!