As a homeowner, you may want to consider refinancing at some point during the life of your mortgage. It could be lower mortgage interest rates have become available since you first took out the loan, and refinancing would reduce your payment. Or you may want a cash-out refinance so you can do some home remodeling. There are some things to consider before you apply for a refinance loan to be sure this is the right path for you. Take a look at these key factors before deciding.
Know How Much Home Equity You Have Built
To refinance, you will need to have some equity in your home. Over the last several years, home values have risen in the U.S., so your home's value has likely gone up. Most lenders will not lend you money for a refinance if you don't have equity built up on your home. There may be some government programs that are available to you if this is the case. Generally speaking, you will have a higher chance of being approved for a refinance loan if you have at least 20% equity built up in your home.
Know Your Current Credit Score
Your credit score plays a significant factor in whether you will be approved for refinancing. It will also affect the interest rate that you receive.
You can get a free credit report by contacting one of the three credit reporting agencies. A free report is available every year from each of the companies. You'll have the opportunity to see the same credit history that lenders use when determining whether they will approve you for a loan. If you have credit cards where you're holding high balances, this will affect the credit score. Paying these down faster will help improve your credit score.
Determine Your Debt-to-Income Ratio
Your debt-to-income ratio takes all your monthly debt and compares it against your gross monthly income. The result determines your ability to repay debt. Lenders have their own set of requirements of what your debt-to-income ratio should be below. You may need to provide documentation such as tax returns and pay stubs to verify your gross income to a lender.
How the Interest Rate and Terms Work
When choosing a lender, it's easy to focus on finding the lowest interest rate. However, consider your reasons for refinancing the mortgage. If you wish to lower the monthly payments, then the goal is centered around finding the lowest interest rate, which will likely have a longer-term. However, if your goal is to pay less interest and pay down the loan as soon as possible, you will want to focus on finding a shorter term.
Costs of Refinancing
In most cases, it will cost between 3% and 5% of the total loan amount to refinance your loan. Some lenders will allow you to roll these costs into the new loan, which increases the principal. Other lenders will offer a higher interest rate on the loan to cover these costs.
Another cost associated with refinancing is points. In most cases, a point is equal to 1% of the loan amount and is used to lower the loan's interest rate. Points will be paid at the closing of your new loan. Be sure to review points with each lender.
Private Mortgage Insurance
If you have less than 20% equity built up in your home, your lender will require private mortgage insurance (PMI). If your home's value has decreased since your purchase, you might find that you will need to pay PMI. If you have already been paying PMI, this might not be an area of concern. Your lender should be able to tell you whether you will need to pay PMI and how much the monthly cost will be.