October 20th, 2009
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In this sunny mortgage climate, you might be wondering if you should join the recent frenzy of home refinancing. If you are interested in locking in a lower interest rate, reducing your monthly payment, shortening the term of the mortgage, or switching from a risky variable-rate loan to a secure fixed-rate loan, refinancing might be a good move for you.
But, there are many considerations to take before you jump in the bandwagon with other homeowners. You have to first qualify to refinance your home, pay for upfront costs, and if you are underwater on your mortgage, then you’re out of luck. Also, it will take a few years before you actually start saving money on your new mortgage. While refinancing is a great option, here are a few questions to ask yourself before you take the refinance plunge.
- How’s your credit score? If your overall credit score is low, you can forget about refinancing right away. Lenders have raised the bar on the type of homeowners they approve, so if your credit score isn’t at least 740, you probably won’t be approved. If your credit score isn’t ready for refinancing, take a few months to improve your credit history through on-time payments and polishing up your credit report by checking for errors and inaccuracies that ding your score. Just cross your fingers that mortgage rates will remain at a record low a few months down the road when your credit score is stellar and you are ready to refinance.
- Do you qualify? Another factor when applying to refinance your loan is your loan-to-value ratio, or LTV ratio, in which you divide the loan amount of your current mortgage by the value amount. You need an 80% LTV ratio to qualify for the best refinancing rates, which can be a feat considering decreasing property values have dropped many homes below their original purchase price. Look on some websites such as Zillow or do some research at your local Registry of Deeds to get a range of what houses are selling for in your area. If you owe way more than your house is now worth, forget refinancing—it’s not going to happen.
- Will you save $$ or not?This is the most obvious question—refinance your home if it’s worth it. If it won’t save you a significant amount of money in the long run, then don’t bother. The old rule of thumb was that if you can recoup the cost of your refinance in a year, then it’s worth it; however, that doesn’t take into account closing costs and other factors that make your refinance tab add up. Refinancing your home is taking out a new mortgage on your home, so you will be paying all the same closing costs, such as application fee, origination fee, appraisal fee, etc., as you did when you first purchased your home. These closing costs are added to your loan. Also keep in mind that lenders structure mortgages so that borrowers pay off interest charges for the first few years, and after that, monthly payments then go towards paying off the principal debt owed. So if you’ve been paying your current mortgage for the last 10 years, you may have already paid off the interest and are now paying off your principal debt. If you were to refinance now, you would have to start over with paying the interest, closing costs, and potentially a longer term on your new loan. Consider whether or not the short term gain of paying less on a monthly basis with a new loan is worth the long term effect of paying more interest from refinancing. Calculate your possible savings from refinancing to gauge if the refinance will be worth the savings.
If you’ve answered all these questions and found yourself itching to refinance your home, now is the best time to trade in your old mortgage for a new, improved loan in this (limited time) golden era of record-low mortgage rates.