While it’s true that a home refinance can lead to lower mortgage payments, potentially saving you money over the life of your home loan, the ideal time to refinance involves more than dollars and cents.
Here are a few important financial questions to ask yourself to determine whether now is the right time to look for a new home loan.
How Stable Is Your Financial Life?
Remember all that paperwork you submitted to secure your current mortgage loan? You’ll have to do it all again when you pursue a new loan, even if you refinance with the same lender. At a minimum, be prepared to provide proof of:
- Your employment and income history, including recent paycheck stubs.
- Your assets, including bank and investment account statements.
- Copies of recent and past federal tax returns.
- Current balances on your loans and credit cards (the lender can also pull your credit report for the information).
The experts at the Consumer Financial Protection Bureau note that mortgage borrowers ideally shouldn’t have a debt-to-income ratio of more than 43 percent. Divide the current monthly debts on your credit report by your gross monthly income, which is your income before taxes and other deductions. If your ratio is above 43 percent, it may be better to pay off some of your debts before you apply to find competitive loan rates and terms.
How Much Equity Do You Have in Your Home?
Many lenders now require that homeowners have at least 20 percent equity in their home (based on the home’s market value, minus any remaining mortgage balance) to refinance. To estimate your current home equity, compare your mortgage balance to your home’s estimated market value using your county auditor’s website, a recent appraisal or a site like Zillow.
What Do You Want to Accomplish?
Once you’ve checked the above items off your list, consider these questions about what you want to achieve with a new loan:
- Do you have an adjustable-rate mortgage? Interest rates are expected to rise at least two more times in the next year, so now may be the time to lock in a home loan with a fixed interest rate if you currently have an adjustable-rate mortgage.
- Do you want to lower your monthly mortgage payments? A loan with a lower required monthly payment (and, ideally, a lower interest rate) could ease your burden if you’re struggling to keep up with your current mortgage payments. If you owe more on your home than it’s worth, you may want to explore refinance programs offered through Freddie Mac, many of which are designed to provide financial relief to homeowners.
- Do you want to pay off your home quickly? Refinancing into a home loan that offers lower interest rates without extending your current mortgage term could help you own your home in the same number of years at a lower cost over the loan’s life. If you refinance into a shorter loan term — for example, a 30-year mortgage down to a 15-year — you could secure an even lower interest rate and reach financial independence sooner than you otherwise would.
- Are you willing to pay cash for low rates? If you’re looking for an instant return on investment for cash you have on hand, you could benefit from buying discount points on a home refinance to secure even lower interest rates on a new home loan.
- Do you have debt? If your home has appreciated rapidly, a cash-out refinance could help you pay off high-interest debts or fund renovations. In this type of transaction, you refinance your mortgage balance and tap its home equity to take out a larger mortgage loan. The bigger loan amount gives you access to cash but allows you to borrow at a low interest rate.
- How long will you stay in your home? Run the numbers with a home refinance calculator to determine how long you need to own your home after you refinance to recoup your costs.
Understanding your answers to these questions will help make the decision to refinance anxiety-free so you can get on with what’s actually important: creating a promising future for your family.