As markets change, interest rates move up and down. When rates are moving down, people may be inclined to refinance higher-interest loans, replacing them with new loans at a lower rate and with a new lower monthly payment.
Knowing when to refinance, and when not to refinance, can save you money. Refinancing at the right time can make paying your home loan easier, improving your quality of life. Here's what you need to know.
Questions to ask (and answer) before refinancing
Some people refinance to reduce their monthly mortgage payment. Others refinance to save money over the long term, shaving years off their mortgage. Before you choose to refinance, ask these questions to determine whether refinancing is possible, and if doing so will accomplish your goals.
Do you have the equity?
Generally speaking, homeowners must have about 20% equity in their home to refinance. Homeowners who have less than 20% equity may still be able to refinance if they have good credit. Talk to a lender to help you decide whether you have the equity or good credit to make refinancing possible.
How much would it cost to refinance?
Lenders charge borrowers fees when they take out a new loan. These costs help lenders manage the risk of lending and compensate them for the administrative tasks they must perform to lend money. Some standard costs associated with refinancing a home mortgage include:
Closing costs. In order to close a loan, a borrower must pay a variety of fees such as loan orgination fees and underwriting fees.
Discount points. Points are paid to the lender upfront to reduce the interest rate on a loan; this helps reduce the borrower's monthly payments and reduce the total amount paid over the life of the loan.
Appraisal. Before lending money, lenders require homeowners to get an appraisal to determine the value of the home; this usually costs several hundred dollars.
What would you save?
You can calculate your total savings by comparing the cost of your former interest rate and the cost of your new rate over the life of the loan. Remember to include in the cost of your new rate the fees you will pay to the lender as part of the refinancing. Many lenders have online calculators that allow you to input your loan amount, interest rate, and loan term to come up with a monthly payment amount.
How do current mortgage rates compare with your rate?
If you originally took out a fixed-rate mortgage, you've probably been paying the same interest rate for years. If rates are significantly lower now than they were when you borrowed, then taking out a new loan could dramatically reduce your monthly payments and the amount you pay over the life of the loan.
If you had taken out a variable rate loan and interest rates are now low, it might be time to lock in a fixed-rate mortgage. If you are paying a variable-rate mortgage, you may not be aware of how much you're paying in interest; your lender can help you determine your costs and how much you could save.
Would you pay more over the life of the loan?
Be aware that refinancing from one 30-year loan to another 30-year loan will extend your payments. Your monthly payments will be reduced, but you will have more of them spread over the new term of your loan. For this reason, homeowners often will decide to shorten the loan term when they refinance if they can do so without significantly affecting their monthly payments. A good lender will help you consider all these options and how they would affect the amount you would pay over the term of the loan.
Finding the answers, shopping around
Always shop around when refinancing a loan. Fees vary from one lender to another, as do rates and payment terms. Shopping around is the best way to get a good deal and to find a lender that has the right loan for you.
As you contact lenders, ask them questions about the loans they offer, their payment terms and the paperwork you would need to provide in order to be approved. Asking questions is a good way to compare lenders and can ultimately help you decide which one to choose.
Are you ready to refinance?
Before refinancing, check your credit score. If you have good credit (740 and above is optimal), you're more likely to get a good deal on a new home loan. If your credit leaves something to be desired, you may be better off waiting until it improves.
In addition to a good credit score, you'll need to be employed and have a solid employment history. Your lender is likely to ask for various forms of financial paperwork, such as records of your bank statements, which you'll need to produce before a loan can be approved. As you talk to lenders, ask them about the specific paperwork they'll need in order to approve you for a new mortgage. Gather that paperwork ahead of time so you're ready when they ask for it.
