If you have a mortgage now, you may wonder if refinancing is the right answer. It seems like everyone is doing it today, so you should too, right?
It often makes sense to refinance so, but first, you should understand what’s involved and when you should avoid it.
How to Refinance – What’s Required?
Before you decide if you should refinance, know what’s required. It’s a lot like when you bought your home and took out a mortgage, only this time there’s no sales contract.
To refinance you must prove you can afford the loan by proving you have the following:
- Average to good credit
- Stable employment and income for the last 2 years
- A debt-to-income ratio lower than 43%
- No recent bankruptcies or foreclosure
- Equity in your home
Depending on the type of refinance too, you may need proof you benefit from the refinance, such as lowering your payment or decreasing your interest rate.
The Benefits of Refinancing
Most people benefit from refinancing in one of the following ways.
A lower interest rate
If you lower your interest rate you save money each month and over the life of the loan. For example, a $200,000 30-year loan at 4.5% costs $164,813 in interest over the loan’s term, but a rate of 3.5% costs only $123,312 in interest, or a savings of $41,501.
A better term
If you are in a better financial position, you may be able to afford a 15 or 20-year term payment versus a 30-year payment. Shaving 10 to 15 years off your loan can save you thousands of dollars in interest. Using our $200,000 30-year at 4.5% example, you’d pay $164,813 in interest but over 15 years at the same rate, you’d pay $75,397 in interest!
Tap into your home’s equity
If you built equity in your home but you need to cash some of it out to pay for home renovations, medical bills, debt consolidation, college costs, or anything else, you can refinance and take out the equity, taking advantage of today’s low rates.
Eliminate Mortgage Insurance
If you have an FHA or USDA loan, you’re likely paying mortgage insurance. If you owe less than 80% of the home’s value, though, you may be able to refinance into a conventional loan with no PMI. If you have good credit, a low debt ratio, and stable employment, you may be able to lower your payment.
How to Tell if Refinancing is Right for You
Before you refinance, make sure it makes sense. If you’re refinancing just for the lower payment and not to take equity out of your home, use this equation to determine if it’s right.
Total closing costs/Monthly savings = Break-even point
Your break-even point is the number of months it takes to pay back the closing costs you paid for to refinance. If it takes more than a couple of years to recoup the costs, it doesn’t make sense to refinance.
Refinancing can be a great way to save money or change your loan’s term. Before you do, check the math, make sure the closing costs, new rate, and new term make financial sense not only today but in the long-term too.