We’re sharing the key factors to consider when refinancing a mortgage.
Are you one of the over 60 percent of Americans who have a mortgage?
If yes, it’s possible that you might be asking: should I refinance my mortgage?
First things first, thumbs up for being a homeowner! At a time when the number of people renting is increasing by the day, it can be easy to feel that taking out a mortgage was a bad decision. On the contrary, buying a home, whether in a cash or via mortgage financing, is one of the smartest investment decisions you’ll ever make.
However, a mortgage comes with a unique set of challenges. This means you might want to refinance at some point. But is refinancing a good decision?
In this article, we’re sharing the key factors to consider when refinancing a mortgage.
What’s Mortgage Refinancing?
Before we dive into the factors, it’s essential to define what refinancing is.
Broadly speaking, refinancing is the act of taking out a new loan to replace an existing one. As such, refining a mortgage means taking out a new mortgage to replace the current one.
In most cases, refinancing will lead to a loan with better terms. You’ll likely get a lower interest rate or an extension on the term of the loan.
Now that you know what mortgage refinancing is, let’s turn out attention to the factors you need to consider before taking the step:
1. Your Goals
Why do you want to refinance your mortgage?
If you’re anything like most mortgage holders, you’re probably looking at the interest rate. This is super important, sure, but a lower interest rate doesn’t necessarily mean you’ll meet your goals.
Typically, there are two major goals:
- Reducing your monthly repayments
- Repaying less interest on the loan.
Which is your goal?
If you want to reduce your monthly payments, possibly because your income is tight, refinancing can help you achieve the goal. You just need a new mortgage with lower interest or a longer term or both.
Here’s an example.
If you’re currently paying $800 a month on your mortgage and you have a 15-year loan, you’ll be able to substantially reduce this payment if you can refinance and get a 30-year loan. Getting a lower interest will also achieve a similar effect. Ideally, you want a combination of both.
If your goal is to reduce your total interest payment, refinancing can also help.
For example, a 30-year, $250,000 mortgage charging 5 percent interest annually will attract a total interest payment of $375,000. If you want to pay less than this, refinancing the loan to a 15-year mortgage will be the right thing to do. A lower interest rate, as you already know, will help.
2. Your Credit Score
If you have a traditional mortgage, you already know lenders have high credit score requirements. The fact that you have one means your score was good, at least.
Refinancing needs a similar credit score, if not better.
If your credit has fallen since you took out a mortgage, you might want to rebuild it before you start refinancing. With bad or poor credit, your refinancing application will certainly be rejected.
Credit score requirements are usually lighter for non-conventional loans, such as VA loans. But still, lenders will require your credit score to meet a certain threshold. That being said, a VA streamline is a sure path to a better mortgage.
3. Home Equity
The difference between what you owe on your mortgage and the home’s current market value is your home equity.
If you owe $100,000 and the value of your home is $350,000, you’ve got positive equity in the home ($150,000). If what you owe is greater than the value of your home, you’ve got negative equity.
It takes time to build good equity in your home, but it’s a big consideration when you’re looking to refinance. Lenders want to see that you have healthy equity in your home as one of the requirements for approving your refinancing application.
If you don’t know your equity, hire a property appraiser to value the home. If you’ve got good equity, you can proceed with your refinancing plans, as long as you’ve met other requirements.
4. Your Level of Debt Compared to Income
Mortgage refinancing is just like taking out any other loan. Your lender will consider whether you’ve got other active loans as well as the level of your income before making a lending decision.
If you’ve got a high debt-to-income ratio (most of your income is going to loan repayments) it’s unlikely that your refinancing application will be approved.
The good news is there are steps you can take to lower your debt-to-income ratio. Pay off as many loans as you can, including credit card balances. You can also add another stream of income.
5. Economic Conditions
Economic conditions have a big influence on mortgages.
For instance, when FED interest rates are high, mortgage rates will be high. When FED rates are low, mortgage rates will follow suit.
If you took out your mortgage when FED rates were high and they have now fallen significantly, it’s possible that you’ll get a lower rate on your refinanced mortgage.
When the economy is struggling or slowing down, lenders are more reluctant to approve consumer loans. But when the economy is expanding, lenders approve more loans. So there’s that to consider too.
Should I Refinance My Mortgage? It Depends
Should I refinance my mortgage? Will my application be approved?
These are some of the questions that will be on your mind when you’re considering refinancing your mortgages. However, whether you’re ready to refinance or not depends on a number of factors. Some of these factors are in your control and others are out of your control. After reading this, you should be in a better position to make an informed decision.
Keep reading our blog for more insights and advice.