Should I Refinance My Mortgage?
Dear Lifehacker! Interest rates are so low these days that I am considering refinancing a mortgage loan. However, I am concerned about closing costs and other potential downsides to refinancing. How can I decide if it is worth refinancing now or not?
Signature, reflecting on Refi
Dear Ruminating! This is definitely a good time to consider refinancing as rates are at historic lows . Depending on your current rate and loan, a lower interest rate can save you hundreds in your monthly mortgage payment. However, you should weigh the pros and cons of refinancing before rushing to apply for refinancing. Here’s a three-step plan for making a decision.
Step one: look at your finances the way a lender would
Just like you prepared for your first mortgage loan, you need to sort out your finances before refinancing to see if you qualify for it. Lenders use the same criteria for evaluating refinancing loan applications as home loans:
- Your credit score and history: Free credit monitoring services Credit Sesame and Credit Karma can assess your score, and you can get a free annual credit report at AnnualCreditReport.com . It’s time to fix any errors you find in your report ( over a quarter of reports contain errors!). You will be eligible for the lowest rates if you have an excellent credit rating (740 to 850). If your credit rating is around or below 600, you will likely find it harder to refinance, so you should consider ways to improve your credit rating before applying.
- Your Income, Debt, and Monthly Housing Payments: As with your first mortgage loan, lenders will keep an eye on your income and payment obligations to make sure you can afford the loan. This calculator from Bankrate will show you the income you need to get a mortgage with different interest rates. It is based on a standard payment-to-income (PTI) recommendation of 28% – your debt and other liabilities should not exceed 28% of your monthly gross income. (However, mortgage program rules differ. In addition to the 28% rate, there is another general recommendation that monthly mortgage payments plus other debt obligations should be no more than 36% of your pre-tax income.)
- The value of your home now: The more equity in your home, the better. Many lenders require your loan-to-value (LTV) ratio to be less than 80%, which is the size of your loan divided by the assessed value of the property. However, if you are underwater because the value of your home has dropped, there are several government programs that can increase your LTV . If you’re not sure how much your home is worth today, you can get an estimate from Zillow , keeping in mind that the estimate is not as accurate as the actual estimate. Then find your LTV using this calculator .
With the information above, you should understand how easy it will be to refinance. One final calculator you might want to try: this qualification calculator from a mortgage professor that will tell you what types of loans you can qualify for based on your credit rating and history, income and debt repayments.
A special note if you are self-employed: getting a mortgage is known to be more difficult than it would be if you were an employee, as lenders see you as a greater risk and will require additional filing (such as two-year tax returns). Having a large emergency fund or other assets can help .
Step two: compare mortgage rates
Most people want to refinance in order to get a lower monthly payment, but refinancing can also help you switch to a more preferred type of mortgage (for example, a fixed mortgage instead of a regulated one, or a 15-year instead of a 30-year mortgage.) And / or get cash for home renovations or for other reasons. If you have an adjustable rate mortgage, you should definitely consider refinancing because rates will inevitably rise from these record lows. (Freddie Mac predicts a 30-year fixed mortgage will be 5.5% in 2016, up from 3.8% today.)
This previously highlighted interactive mortgage map can help you compare different loan types with your current mortgage and show you how much you can save if you refinance. For special situations like eligible VA loans, getting cash and / or self-employed, check out Zillow’s personalized rates here .
When using these tools, you will want to compare not only the monthly payment and interest rate, but also the total costs over the term of the refinanced loan.
Step three: find the break-even point
Finally, the key factor is how long you plan to stay at home. If you are planning to move in a couple of years, refinancing may not make financial sense because even with lower monthly payments, you may not be able to recoup the final refinancing costs in time.
According to Bankrate , closing refinancing costs can be 2 to 3 percent of the loan amount ($ 2,000 to $ 3,000 for every $ 100,000 of your loan). To find your breakeven point, divide those closing fees by the monthly savings you expect from refinancing, or use this calculator to figure out the numbers. This will tell you how many months it will take you to break even. Here’s an example:
In the example above, you will recoup the cost of refinancing in two and a half years, so if you plan to stay in your home for longer than that, the savings outweigh the costs. Generally, if you can recoup the costs in two or three years and plan to stay in your home for much longer, refinancing is probably a good move.
Consider the loan term
One final consideration is how many years you have left on your current mortgage. If you have 20 years left on your 30-year mortgage and refinance to a new 30-year mortgage, you are extending until the house is vacant and vacant. This is an important factor if you do not want to have mortgage obligations in retirement.
Also, keep in mind that depending on the new loan term, although the lower interest rate will lower your monthly payments, you may pay more in the total interest over the life of the loan compared to your current mortgage. You may want to consider a 15 or 20 year mortgage instead of a fixed 30 year mortgage. With a shorter loan term, your monthly payments may be the same or slightly higher, but you will save tons of interest over the life of your mortgage. You will find more advanced calculators to see if refinancing makes sense for different scenarios at Mortgage Professor .
In the end, the decision to refinance depends on the quantity and whether you want to refinance to lower payments, pay off your mortgage faster, get cash or consolidate loans. For many people who have not refinanced yet and have a mortgage loan of 1% or higher than current rates, it is definitely worth considering this before rates rise.
Good luck Lifehacker