What are the factors to consider when refinancing? Here's a checklist that might help you make a better choice and get a better deal:
1. Have You Found the Lowest Interest Rate?
The interest rate you pay on your new mortgage refinance may not be the only consideration, but it has to be the main one. That's because shaving even a little off a rate can save you thousands of dollars when you're paying back a high-value loan over many years.
There's no shortcut to getting the best rate, though it's a lot easier and quicker than it used to be. No lender or broker is obliged to offer you the best rate, and you need to shop around, get competitive quotes and compare them. Do that online, and it could all be over in minutes.
2. Have You Chosen the Right Loan?
If they can afford the higher monthly payments, many homeowners prefer to refinance to a shorter mortgage of 15 or 20 years. That way, they pay way less interest overall and are free of the debt much sooner. However, whether or not that's a smart move depends on the borrower's personal circumstances, needs and ambitions. You can find out more at The Benefits of Having a Long Mortgage.
If you have firm plans to move home again within a few years, you might be better off opting for a hybrid adjustable-rate mortgage (ARM). These have an initial period during which the rate is fixed (often three, five or seven years, though sometimes 10), and the interest you pay floats only when that period expires. Given that interest rates on ARMs almost always start out considerably lower than those for fixed-rate mortgages, these can save you serious money providing you do move within that initial period. Of course, they come with pros and cons.
3. Have You Picked the Right Lender?
Refinancing through your existing lender might turn out to be your best move. However, there's no guarantee that will be the case (see Should You Refinance with Your Current Lender?) and you won't know for sure unless you carry out that comparison shopping exercise described above.
You might also want to take into account how good the lenders you're considering are at dealing with customers, and how efficiently they handle applications and manage accounts. A recent report from Ellie Mae found that in January 2016, it took an average of 48 days to close a refinancing application, but some lenders are hopelessly inefficient and that time can sometimes double. Read real-life reviews from actual customers to find out how your candidate lenders managed their applications.
4. Do You Know the Value of Your Home?
You must have a reasonable idea of the amount of equity you have in your home. Equity is the current market value of your home, less the balance on your mortgage and any other loans – usually home equity loans and lines of credit – that are secured on it. Your equity counts as your down payment, and the bigger it is, the lower the rate you're likely to be offered. And, of course, if you're going for a cash-out refinance, it will determine the maximum sum you're able to walk away with. It's easy to establish your mortgage balance from your most recent statement, but estimating your home's value takes a little more effort.
Do a little research online to find actual sale prices (not asking prices) in your neighborhood and area, or maybe call a friendly real estate agent. This isn't a time to be overly optimistic or pessimistic. Your lender's going to send around a professional appraiser, so there's no point kidding yourself.
Are You Appraisal-Ready?
Don't forget you can boost the value of your home by making minor improvements, such as decorating and yard work, and getting it clean and tidy. Think of your appraiser as a home buyer. For tips, see How to Prepare Your Home to Sell this Spring.
But don't get carried away: you don't want to spend more on improvements than they'll add to your home's value. And don't open new accounts or borrow significantly on your plastic to pay for the work, or you risk lowering your credit score.
5. Is Your Credit in Shape?
Speaking of which, according to FICO, the average rates quoted for a refinance application made in mid-March 2016 for a $200,000, 30-year, fixed-rate mortgage would see monthly payments $185 higher for someone with poor credit (a score of 620-639) than for someone with great credit (760+). Over the 30-year term, that would add up to a loss of $66,600, just as a result of having a low score. It really is worth paying attention to this.
Before you apply, get your credit score. It's free through this LendingTree service, and you'll also get monthly updates and customized hints for improving it. You should also apply for your credit report, which is the detailed history on which scores are calculated. You're legally entitled to receive this free once each year from AnnualCreditReport.com, and you should certainly check it at least that often for errors, which are much more common than you may think.
It's also a good idea to pay down as much other debt as you can before you apply, because the lender that refinances your mortgage will want to be reassured that you can easily afford payments. If too much of your household expenditure is currently going on servicing debt, you may get a worse refinancing deal. However, that lender may be more understanding if you undertake to pay down some or all your secondary debts using the proceeds of a cash-out refinance.
6. Are Prepayment Penalties Going to Affect You?
A prepayment penalty may be charged by a lender if you redeem your mortgage early when you sell or refinance your home – but only if your mortgage contract allows it. So check your current agreement to see whether you're going to be charged, and, if so, how much. You then have to build that additional cost into your other figures to make sure your refinance is still economically viable.
There may also be a prepayment penalty clause in your new refinance agreement, especially if your new lender is covering or helping with closing costs. These clauses can be fair and reasonable, but you should be aware that they might affect your options in the future.
7. Are You Ready?
Some lenders can hold up refinances through their inefficiency. But many borrowers add to delays by taking too long to provide information and supporting documentation. Use this checklist of refinance documents you may need to get yourself on the fast track.
Of course, there are many, many factors to consider when refinancing. But these are some of the most important, and they may make the difference between your getting a good deal or a great one.