A year after the housing bubble burst, I decided to make a career change and go back to school for my MBA. During one of my first finance courses, my professor discussed her reasons for refinancing her home mortgage at that time. Despite the housing crisis, high unemployment and poor economy, for those who had plenty of equity in their homes, it was a good time to refinance. Mortgage rates were falling, and lenders were willing to negotiate.
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There are a number of benefits to refinancing a mortgage, but doing it at the wrong time can lead to underwater mortgages and even foreclosure. Here are six important questions to ask when considering refinancing a mortgage.
1. How much equity do you have in your home?
A homeowner must have at least 20 percent equity in their home in order to avoid having to pay for private mortgage insurance. The more equity you have in your home already, the less you will end up having to pay over the course of the loan. Still, for those who do have a lower equity in their homes, refinancing may still be a viable option through specific programs.
2. What is your credit score?
Just as it was when you initially purchased your home, your credit score will be an important factor when you refinance. A higher credit score will help to ensure you will be able to get a better interest rate. Since one of the main purposes of refinancing is to get a better rate, it is important to make sure you have a good credit history. If your credit score is not where you would like it — say if it’s below 700 — you may want to work on building up your credit first before refinancing.
Related Article: 3 Smart Reasons to Refinance Your Mortgage
3. What are your goals?
Refinancing a mortgage can be beneficial, but it’s important to be clear on what it is you are trying to accomplish. Are you looking to shorten your mortgage? Decrease your monthly payments? Change from an adjustable-rate mortgage to a fixed rate? These are important questions that will help your recognize your goal and therefore make the best decisions to meet it. Remember to include other financial aspects in this goal, such as your current level of savings, proximity to retirement and more.
4. What are the terms of your current mortgage?
This goes along with question number three. Do you currently have an adjustable-rate mortgage (ARM) and are you looking to switch to a fixed-rate? With an ARM, your monthly payment can jump a few hundred dollars from one month to the next. To avoid these changes, a fixed-rate mortgage may be best, but you need to be aware of what your terms are. Be sure to thoroughly read and understand your current loan and your new loan.
5. Can you afford to refinance?
There are additional costs associated with refinancing, including closing costs paid to the lender to process your loan. These fees can add up and cost you thousands. While you may be able to get these costs absorbed in your loan, it may raise your monthly mortgage, making the refinance not worth it. Remember to add up all the costs of refinancing while you’re planning.
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6. Do you have the time to dedicate to researching your best options?
There is a bit of work and research that’s associated with refinancing. You need to be aware of your own financial position, what your goals are, the terms and conditions of your current loan and more. In order to get the benefits you are looking for through refinancing, you must be willing to put in a little effort to answer the above questions and to search for the best refinance options, otherwise you may find yourself stuck with a loan that is not favorable. If you do not have the time or energy to do this research, it may best to wait.
Refinancing a home mortgage is not a small decision. Refinancing will not only impact your mortgage payments, but also the entirety of your financial portfolio, as it will affect your overall wealth. Asking yourself the six questions above will allow you to make the best decisions so you can reach all of your financial goals.
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