If you’re looking to lower your interest rate to pay less interest over the years, then it could be time to refinance – but not before considering these factors.
Mortgage refinancing can be complex and require extensive due diligence on the part of lenders and homeowners alike. There are many components to determine if you are eligible and if a refinance would be beneficial. So, while it may seem like the right time to refinance if interest rates fall to a new low, there are a few factors to consider before refinancing.
What is a Refinance?
A refinance is a loan that replaces an existing one to get a better rate or better terms. The first loan is paid off and replaced with a second loan. Homeowners can often customize exactly what they need out of a refinance and choose their preferred rate, fees, loan length and the amount borrowed, although it will depend on the lender and the homeowners’ qualifications.
Traditional vs. Cash-Out Refinancing
There are two main ways to refinance a mortgage. The first is the traditional refinance that uses a lower interest rate and reworks the terms to pay less money over time. Many use this type of refinancing to have a lower monthly mortgage payment and pay less in interest throughout the loan term.
The other method is cash-out refinancing where the applicants get money back from a bank by tapping into the equity in their mortgage.
How Much Time Is Left On Your Current Mortgage?
Not only do you need to consider how long ago you’ve purchased the home and how much equity is built up, but how long you are planning on staying after you refinance.
Some lenders won’t refinance a mortgage if not much time has passed since the property was purchased. If you have only made a few years worth of payments on your current mortgage, and you have a choice between a 30-year or a 15-year term, choosing the 30-year term will likely lengthen the amount of years you repay your loan in even though it might lower your payment.
On the other hand, choosing a 15-year term will increase the monthly payments but would also result in paying off the mortgage faster, and you'll pay less overall in interest. It all depends on the amount of equity built up and how many years you have already paid off on your loan.
The best time to refinance is when you can get both a lower monthly payment and save interest over the long run.
If there is enough equity to be able to refinance, then determine if you are going to be keeping the property a while longer. Between the costs to refinance, it will take some time to break even and start saving money. The costs of refinancing are usually between 3% and 6% of the total loan amount.
If you’re thinking about selling the property within a few years, it is best to keep the same loan that you already have. This is an important calculation to consider in the decision to refinance. Your loan officer can help with those calculations if you do choose to move forward with refinancing your mortgage.
Interest Rate Savings
Falling interest rate is one of the biggest reasons people consider refinancing their debt. This rate has the potential to dramatically change how much interest you will pay over the years, which could add up to thousands of dollars worth of savings. While there could be a benefit to refinancing with any interest rate lower than the one you already have, it is best to find an interest rate at least one percent lower than your existing rate.
Take the time to shop around to find the best interest rates. Different lenders can also offer perks such as reduced refinancing fees – so while shopping around, be sure to negotiate and take these fees into consideration.
Do You Qualify?
Just because you are making payments on time on your loan doesn’t mean you automatically qualify. Lenders have tightened the standards for loan approvals in recent years, so you'll need to present well as a borrower needs to be in order to be able to refinance. Even a good credit score might not always qualify for the lowest interest rates. Lenders want to see an exceptional score of 760 or higher to approve a loan with the lowest rates possible.
Another factor to consider is the debt to income ratio. While you may have qualified for the first loan on your current mortgage, a new lender may require a different debt to income ratio.
Typically, lenders like to see less than 36% of the overall debt to income ratio. It is generally a good idea to pay down any debt to increase the likelihood of qualifying for a refinance.
Unstable income is another factor that lenders look at that plays a big role in whether you will qualify or not. Lenders like to see a long and stable job history that will prove to them that you will have great income for years to come and are able to consistently make payments on the loan.
A savings account with a healthy balance can also be a helpful tool to increase your odds of getting a good loan.
It’s important to establish your goals when refinancing to be able to determine if now is the right time to move forward. Then take it further by going through each of the factors and determining for yourself if you are in a good position to refinance. If you have determined you have poor credit or a high debt to income ratio, then try to improve those things before applying. Once you're confident you're in a strong position to qualify for a refinance, speak to a lender to decide whether it is right for you and what you can do to benefit from a mortgage refinance.