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11 Things to Consider Before Your First Mortgage Refinance

Written by Posted On Tuesday, 17 November 2020 11:13
11 Things to Consider Before Your First Mortgage Refinance

With interest rates at historic lows, homeowners in the United States are rushing to refinance their mortgages. Nearly two out of every three mortgage applications are designated as refinances, according to the Mortgage Bankers Association. But if you’ve never refinanced before, where should you begin? 

 

You’ll find a wealth of advice out there for first-time homebuyers. But if you’re a first-time refinance borrower, it can be hard to find. Here are 11 things to keep in mind if you’re refinancing your mortgage for the first time.

11 tips to help you navigate the refinancing process for the first time

When you refinance your mortgage, you take out a new loan on your home that pays off your original mortgage and replaces it with a new one. Many people consider a refinance when interest rates fall. If the interest rate on your new mortgage is significantly lower, you can reduce your monthly payment and total interest paid over the life of the loan.

1. Understand your financials

The terms of your mortgage refinance will be dictated by your financial situation — especially the interest rate you receive and how large a loan you qualify for. Make sure you’re familiar with the following to better understand your options. 

    1. Credit score. Your credit score is a number that gauges how likely you are to repay a loan. The higher it is, the better the interest rate you are likely to get on a mortgage refinance loan. 
    2. Equity. Home equity is the difference between what you owe on your mortgage and what the home is worth. When you refinance, your lender will order an appraisal to determine the market value. If you don’t have enough equity, you may not qualify for a refinance loan.
    3. Debt-to-income (DTI) ratio. This measures your monthly payments on any loans you have, compared with your monthly income. If your DTI ratio is too high, you may not qualify for a refinance.

2. Think about timing

Before you refinance, consider how long you will stay in your home. It will take some time for your refinance to pay off: The savings on your monthly payments will be offset by the closing costs you must pay on the loan. If you plan to move before this break-even point comes, you may want to hold off on refinancing.

Use a mortgage refinance calculator to see how much money you’d save each month and how long it would take you to recoup your closing costs. 

3. Save up for the closing costs

Refinancing your mortgage is an investment. Refinances typically cost between 2% and 6% of your loan amount in cash as closing costs of the loan. This equates to between $5,000 and $15,000 on a $250,000 mortgage.

4. Determine if you still need mortgage insurance

For many mortgage loans, you need to pay a monthly premium for mortgage insurance if you make less than a 20% down payment. This insurance protects the lender in the event that you don’t make your payments. You can typically drop the mortgage insurance once you hit 20% equity in your home. A refinance is a good time to gauge your equity — you may be able to refinance to a loan without mortgage insurance.

5. Think about loan term

Since you are taking out a new loan in a mortgage refinance, you will need to pay attention to the loan term. The most common loan terms are 30 years, 20 years and 15 years. You may choose to shorten your loan term by refinancing, though your monthly payments will likely be higher. You might also choose to lengthen the term of your loan — for example, getting a new 30-year mortgage after five years of your previous loan. This will lower your monthly payment, but you’ll likely pay more in interest over the life of the loan. 

6. Don’t take the first offer right away

Just like when you’re buying a new home, be sure to shop around for a refinance. Get quotes from multiple lenders and see who offers the best interest rate and closing costs. This can save you thousands of dollars over the life of your new mortgage.

7. Decide if you want to take cash out

With a cash-out refinance, you take out a new loan for a greater amount than you owed on your previous mortgage. The balance comes to you as cash. This can be a good way to pay for home renovations or a child’s college education. However, this whittles into the equity you have in your home, so you may want to consult a financial advisor to see if this is right for your situation. There are also other types of home equity loans that may be better for you.

8. Have your paperwork in order

Remember, you’re taking out a new loan when you refinance, so you’ll need to go through the application and underwriting process again. Your refi lender will need to verify your income and assets, so collect your most recent pay stubs, bank statements, W2 forms and tax returns. You’ll also want to avoid big financial moves that disrupt your cash flow, like starting a new job.  

9. Don’t take out any other loans

In general, you don’t want to make any major financial actions while you’re applying for a new mortgage in a refinance. This could interrupt your lender’s underwriting and stop your loan from being approved. 

10. Make sure you don’t have a prepayment penalty

Some mortgages charge a fee if you pay them off early — and a refinance counts. If your current loan has a prepayment penalty, you’ll need to weigh that cost against your monthly savings. Sometimes, you can avoid a prepayment penalty if you refinance with your current lender.

11. Watch out if you have any other home loans

If you have any home equity loans to go along with your mortgage, check to make sure your home equity lenders are OK with a refinance. Some home equity lenders will require you to pay off their loan before you can refinance.

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Callie McGill

Callie earned her B.A. in Advertising from Penn State University and her work on personal finance and housing related topics have been published on Yahoo! News, MSN, Mashvisor and more.

https://www.lendingtree.com/

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