In current market, some home buyers may get excited with the low interest rates; some may be hesitant by the uncertainty of future with so much happening overwhelmingly. On the other hand, refinance becomes undoubtedly attractive to homeowners when mortgage interest rates continue sliding. A refinance replaces your current loan with a new loan, typically at a lower rate. The extra monthly savings could give you wiggle room in your budget to pay down other debt or boost your savings. However, refinance is a complex process. Here are a few things you should know about this process.
Why should homeowners consider refinance?
In case you are completely foreign to this process, I’m going to briefly go over refinance’s benefits. There are many good reasons to refinance, here are five common ones.
- Scoring a lower interest rate. The number one reason homeowners decide to refinance is to secure a lower interest rate on their mortgage. Not only does this save you money in the long run and decrease your monthly payment, but you can start building equity in your home sooner.
- Using an improved credit score. Even if interest rates have not dropped in the market, if you’ve improved your credit score over the last few years, you may be able to reduce your mortgage rate.
- Shortening the loan’s term. If interest rates are decreasing, there is a chance you may be able to get a shorter loan term with little to no change in your monthly payment, allowing you to pay off your loan sooner.
- Switching from an adjustable rate to a fixed rate. If you chose an adjustable-rate mortgage with great introductory rates when you initially financed your home, that rate may increase significantly over the years. By switching to a fixed rate while interest rates are low, you can protect yourself from future increases.
- Cashing out home equity. If there is a big purchase or payment on the horizon, such as funding a wedding or going back to school, your best option may be to use the equity you’ve built in your home to borrow money at a lower cost.
Factors to consider for this process.
1. Home Equity: First of all, you need to find out how much home equity you have. Refinancing with little or no equity is not always possible with conventional lenders. The easiest way to find out is to use some of the popular consumer sites Zillow.com, Redfin.com, or Realtor.com. The best and most accurate way to find out if you qualify for a specific program is to visit a lender and discuss your individual needs. Homeowners with at least 10-15% equity will have better chance.
2. Credit Score: Typically, lenders want to see a credit score of at least 720 or higher to qualify for better interest rates. Lenders have loosen their standards for loan approvals in the last few months, so some consumers may be surprised that even with just decent credit they may qualify for the lowest interest rates.
3. Debt-to-income ratio: Don’t assume that you already have a mortgage loan; you can get a new one. While some factors such as a high income, stable job history or substantial savings may help you qualify for a loan, they are not the only things lenders look at. In general, lenders usually want to keep the monthly housing payments under a maximum of 28% to 31% of your gross monthly income. Overall debt-to-income should be 36% or less, although with some additional positive factors some lenders will go above 40%. Just like when you try to buy a house and get the first mortgage, you may want to be prepared and pay off some debt before refinancing in order to qualify. Again, these standards apply to our “normal” market, you may be surprised with the outcomes these days even if you don’t meet all of these criteria.
4. Refinancing cost: A home refinance usually costs between 3% and 5% of the loan amount. If you have enough equity, you can roll the costs into your new loan, increasing the principal. When you see offers like “no cost refinance”, remember, you pay for it one way or another. Usually that means you will pay a slightly higher interest rate to cover the fees. Negotiate and shop around before committing to a big loan is always a good idea. It is important to figure out whether the costs of refinancing will be covered by your monthly savings, which is the only way for refinancing makes sense for you. For example, if your refinance costs you $2,000 and you are saving $100 per month over your previous loan, it will take 20 months to recoup your costs. If you intend to move or sell your home within two years, a refinance under this scenario may not make sense.
5. Rates and Terms: Do you know you are looking for in a loan? Having a good understanding about rates and term will help determine which mortgage product meets your needs.
*If your goal is to reduce your monthly payments, you will want a loan with the lowest interest rate for the longest term.
*If you want to pay less interest over the length of the loan, look for the lowest interest rate at the shortest term.
*If you want to pay off your loan as fast as possible, you should look for a mortgage with the shortest term at payments you can afford.
6. Points: Points usually equal to 1% of loan amount, which is paid to lender to bring down interest rate. When you shop around for rates and term, don’t forget to put points in consideration. Be sure to calculate how much you will pay in points with each loan, since these will be paid at the closing or wrapped into the principal of your new loan.
Refinancing is a complex process. To be honest, when it comes to houses and mortgage, nothing is simple and easy. Once again, do your homework and consult experts. The good news is there are many resources at your fingertips when you are willing to learn and dig in nowadays. Beside the knowledge you will gain, the amount of saving over time well worth your time and effort.