Rule of Thumb for Refinancing Your Home
Many homeowners consider a mortgage refinance in order to obtain more attractive loan terms. However, refinances do not benefit everyone, and there are good reasons to postpone a mortgage refinance. Before completing a home loan application, evaluate your situation to see if a refinance makes sense.
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Definition
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Refinancing a home involves meeting with a lender and completing a new home loan application. Homeowners refinance for various purposes. Often, they want to reduce their existing mortgage interest rate. Rate reductions result in lower monthly payments, which can resolve payment problems and increase a borrower's personal savings each month. Other reasons to refinance include extending or decreasing a home loan term, or switching from an adjustable rate to a fixed rate.
Credit Rating
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Refinances help lower the interest rate on a mortgage loan. But if you have a low credit score, your lender may deny your loan request or give a higher mortgage rate on the loan. Check your credit history and score first. Ideally, scores should stay above 680. But if refinancing to get the best rate possible, wait until your score is at least 740. Annual Credit Report provides credit reports, while Myfico.com provides personal credit scores.
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Home Equity
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The amount of equity in your property is also a factor in refinancing a mortgage loan. It's wise to postpone a mortgage refinance until you've acquired at least 20 percent equity in the home. In fact, some mortgage lenders will not refinance unless the property as adequate equity. You can wait until the property builds equity over time, or refinance with a down payment. Other loan products are available to help borrowers with little equity. These include Federal Housing Administration mortgage loans that only require 5 percent equity, and programs such as the Making Home Affordable, purposed to help borrowers who owe more or their mortgage than their home is worth.
Break-even Point
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Closing costs are a downside to refinancing a mortgage loan. Before refinancing, consider how long you intend to live in your home. Closing costs are expensive and run about 3 to 6 percent of the loan balance. It doesn't make sense to refinance and pay closing costs and then move before you break even. If saving money each month on your payment with a refinance, divide the savings by the amount paid in closing to assess your break-even point. For example, if your mortgage payment drops $300 a month, and you paid $7,000 in closing costs, it will take 23 months, or almost two years, to recoup the costs of refinancing.
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