6 Questions to Ask Before You Refinance Your Mortgage
When interest rates begin to dip, it's common to wonder whether you should refinance your mortgage.
Like many areas of finance, there's no surefire answer that applies to everyone. However, you can prepare before you decide to make any significant changes. The best way to do that is to ask yourself a few common questions before you refinance.
Understanding your financial situation can help you make the right choice. Here are six questions you should ask before you refinance your mortgage.
1What are my goals with refinancing?
Before you begin the refinancing process, identify what you're hoping to accomplish. There are many reasons you might want to refinance, whether it's lowering your monthly payments, reducing the term of your mortgage or having cash to fund home improvements.
These goals will have an impact on how you might want to approach refinancing. For example, reducing the term from 30 to 15 years can save you money over the long run, but you'll also want to be sure you can afford higher monthly payments.
2What's my credit score?
One of the primary factors that will determine your interest rates for the new mortgage is your credit score. If yours falls in the range that's considered poor credit—usually 300 to 600 on a scale that goes to 850—you could see significantly higher interest rates on the loan. This can add up.
Determine your credit score before you start the process. You can check your current score online. If it's below 700, you might not qualify for the most competitive rates. It may make sense to devote time to determining your credit score before you refinance.
3Do I have equity in my home?
This should be one of the first questions you ask. Ideally, you want to have at least 20% equity in your home. Otherwise, you might have to pay for private mortgage insurance, or PMI.
PMI protects your lender if you default on your mortgage. It can add a substantial monthly premium to your payments, which could defeat the purpose of lowering your rates from refinancing.
If you have at least 20% equity in your home, you could be in a good position to refinance.
4How long do I plan to stay in my house?
Generally speaking, you'll want to stay in your home approximately 3 years after refinancing your mortgage. In that amount of time, many people will hit the break-even point between the offset in monthly savings from the refinance and the total closing costs for the new mortgage.
If you plan to move before that time or you're unsure, refinancing might not be the best option. However, if you're confident you'll be in your home at least 3 years from now, a refinance could be a viable financial option.
5Can I afford the refinancing costs?
When you refinance your home, you're essentially getting a brand-new mortgage. That means you'll have to pay the costs and fees associated with it, including closing, title, attorney and loan origination fees.
These costs often add up to 3% to 5% of the total loan amount. For most people, that means paying a few thousand dollars to complete the transaction. If you can't currently afford those costs, you might want to explore other options. On the other hand, the benefit you get in equity or lower monthly payments might offset the closing costs even if you don't have the cash on hand. A refinancing calculator can help you decide whether it's time to act.
6Have I reviewed my current mortgage terms?
Take a look at your current mortgage terms before you explore refinancing. Read through them fully so you understand any potential penalties or other unexpected fees you might find.
For example, some mortgages have early prepayment penalties. If that's the case, you could have to pay additional fees because you're paying off your mortgage early with the refinancing. That's an extra cost you'll need to consider in your overall calculations.
If you've been wondering whether you should refinance your mortgage, now you have some guidance to help you make the right decision. While there are plenty of potential benefits to refinancing, taking the right preparations can help you see the biggest payoff from this decision. Make sure you're prepared before you take the leap.
A few financial insights for your life
This information is provided for educational purposes only and should not be relied on or interpreted as accounting, financial planning, investment, legal or tax advice. First Citizens Bank (or its affiliates) neither endorses nor guarantees this information, and encourages you to consult a professional for advice applicable to your specific situation.