If you’re like many homeowners, the prospect of refinancing your mortgage has probably crossed your mind at least once or twice.
When mortgage rates are declining, refinancing is a great way to lower the rate on an existing loan and save money on monthly payments.
However, with all the paperwork involved and the time that it takes to complete the process, you might find yourself wondering if it’s worth all of the hassle.
Here are seven things you should do before you start thinking about refinancing your mortgage.
1) Set refinancing goals
Before you refinance your mortgage, set some goals for yourself and what you want to accomplish.
If you’re looking to save money on monthly payments or improve your credit score, those are great goals to have.
By setting some parameters around your refinancing goals, you can figure out if it makes sense for you to refinance your mortgage.
For example, if your goal is to save money and lower interest payments while keeping in line with an existing budget, then it might not make sense for you to refinance right now since that might require extending a new loan and adding more debt on top of your current one.
2) Know Your Home’s Equity
Before refinancing your mortgage, you should know exactly how much equity you have in your home.
Equity is defined as the difference between what a house is worth and what it owes.
Knowing your equity will make sure that you’re not wasting time with a refinance that won’t save money.
According to Discover Home Loans, you may be eligible for a traditional refinance loan for as little as 5% of your home equity.
However, most lenders prefer at least 20% equity.
If you have more home equity, you may qualify for lower interest rates and lower fees because lenders view borrowers with higher equity as having lower credit risk.
More equity also means that if house prices fall, your debt could exceed the value of your home.
3) Check your credit score and credit report
If you’re currently on a mortgage, you may be wondering if now is a good time to refinance.
But before you decide to go through with it, check your credit score and make sure there aren’t any errors on your credit report.
Credit score mistakes can happen, so it’s important to review your credit report with a fine-toothed comb.
Unwanted credit inquiries from new loan applications can affect your score and might cause other lenders to shy away from working with you.
And that’s bad news for any homeowner looking to refinance his or her home.
Plus, low scores could prompt lenders to increase your interest rate by more than 1 percent.
So take time before applying for a new mortgage or home equity line of credit (HELOC) to ensure there are no problems on your credit reports—you’ll have an easier time securing good rates and terms.
4) Calculate the total costs of refinancing
When shopping for a refinance, you’ll have to figure out whether it’s worth it.
Of course, there are all sorts of factors at play—your current mortgage rate, whether you can pay off your loan early, and so on.
But that doesn’t mean there aren’t some things you can do to get a good idea of what your costs will be.
One good way is to use a refinance calculator where you just enter the details about your current mortgage and new home loan.
The cost of completing a refinance is typically between 2% and 5% of the total loan amount.
For a refinance to make sense, you need to be able to amortize these closing costs and save money in the long run.
For example, if your closing costs are $5,000 and you save $100 a month, your break-even point is 50 months or about four years.
In this case, refinancing may make sense if you want to live in your home for more than four years.
5) Get Pre-Approved or Talk To A Loan Officer
First and foremost, if you want to refinance your mortgage, you’ll need to get pre-approved or talk to a loan officer.
While these are two different things, they’re both equally important for making sure that refinancing is right for you.
The first thing your lender will do is look at your finances (credit score and income in particular) to determine if you’re a good candidate for refinancing.
If they approve of your financial status, they may offer to refinance.
The second thing is even more important.
If you’re not approved for refinancing, they will explain why.
And knowing why will help you determine whether or not refinancing is right for you.
For example, if your credit score isn’t high enough, there are steps you can take to improve it before trying again in six months or a year.
And while it might be disappointing at first, having a clear understanding of why you weren’t approved is incredibly valuable.
6) Consider if you want to change lenders when you refinance
The first step in refinancing is to decide if you want to keep your lender or change.
It might seem like a no-brainer, but many homeowners make critical mistakes by not doing enough research.
Before you start shopping around for lenders, do your homework and make sure you’re getting top dollar for your loan.
The best way to do that is to get pre-approved for a new loan by comparing rates from multiple lenders.
If you still don’t see an advantage of switching from your current lender, then that’s probably not an issue.
7) Lock in your rate
A mortgage refinance can save you money in a few different ways.
The most obvious is if interest rates have fallen since you last took out your loan; but it’s also possible to lock in a lower rate when you know interest rates are going up.
There are fees involved in refinancing; you may end up paying an application fee as well as closing costs on top of whatever closing costs you paid originally; but they can be worth it if they let you get a lower rate.
A good rule is that refinancing makes sense when it saves you more than 2% on your overall loan balance; if it’s less than that, consider it very well.
When should I refinance my mortgage?
There’s no one-size-fits-all answer to when you should refinance your mortgage.
On one hand, if interest rates have fallen and you have a lot of equity in your home, you could save a bunch of money each month by refinancing your mortgage.
On the other hand, it may make more sense to stay put if your home value has dropped or you’re underwater on your loan (that is, owe more than what it’s worth).
In addition to doing some math about how much money you could potentially save by refinancing, think through these questions to help determine whether or not it makes sense for you: Will I be moving soon? Does my job situation look unstable? If I refinance, will that impact my credit score? Is there anything else going on in my life that would make refinancing a bad idea at this time?
Keep in mind that if you are thinking of buying another home within three years of your current one, a refinance may have an adverse effect on your credit score.
If that’s something you’re concerned about, keep paying down your mortgage and avoid taking out any new loans.
What does it cost to refinance?
The cost of refinancing varies from state to state and even lender to lender.
Expect to pay 2 – 6% of the total value of your loan.
This can vary depending on what type of loan you are refinancing; FHA loans have lower closing costs than conventional loans.
If you do decide to refinance your mortgage, be sure that your new payment is still within your budget.
In some cases, you can get a no-closing cost refinance without closing costs. Note that closing costs are then paid in the form of higher interest rates over the life of the loan.