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4 Things to Consider Before Refinancing Your Home

Personal Finance
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Mature couple looking at computer and considering refinancing their home

When mortgage interest rates are low, a lot of people tend to think about refinancing their mortgage. In fact, according to the Mortgage Bankers Association, a large portion of all mortgage applications are for refinancing.

If you've been thinking about refinancing your home, there are a lot of important factors to review — especially since refinancing can affect both your mortgage and your overall finances. Here are four things you may want to think through.

1. How Do You Refinance Your Home?

Refinancing essentially pays off your current mortgage and replaces it with a new one. Some people choose to do this because they can get a more attractive interest rate on their existing mortgage, reduce their number of payments or pay off the entire mortgage more quickly, among other reasons.

Keep in mind, if you do decide to refinance, you will likely have to apply for an entirely new loan. The original paperwork you filled out for your current mortgage will likely not apply to a new mortgage, so you'll probably have to collect all the necessary paperwork before you start the refinancing process.

Most banks and lenders will look at your credit score and history, your income, your employment record, and your cash and retirement savings to determine the new rate and terms. You'll likely need to have this information handy, as well as the current value of your home. From there, you can look at the various rates and then apply with the lender that works best for you. They will then help you navigate the process.

2. Who Could Potentially Benefit From Refinancing?

While refinancing isn't right for every situation, it may be an option for those looking for some flexibility with their current mortgage and financial situation. Refinancing may have certain benefits, such as:

  • Lowering your monthly payment: This could free up money that you could put in savings or used to help pay for other expenses.
  • Reducing the overall term of your mortgage: In some scenarios, reducing the term of your mortgage may help you pay off your mortgage faster, but that will depend on how long you've already been making payments. Also, while you may have to pay a higher monthly payment to shorten the term, you might be able to get a more favorable interest rate.
  • Moving to a fixed-rate mortgage: This may be a better option for you than an adjustable-rate mortgage.

The potential savings from refinancing could help you improve your personal finances as well, including paying down debt.

If you are someone who has a good credit score, have seen your home's equity grow and can potentially get a significant reduction in interest rates, then refinancing your home might be an option to further explore.

3. What Are the Potential Costs to Consider?

Just as you have to pay closing costs with a standard mortgage, you will also have to do the same when refinancing.

It's important to understand what additional costs might come with mortgage refinancing. This can help you determine if these costs are in line with your budget and available savings.

Closing costs are typically made up of a variety of fees, such as application fees, loan origination fees and other refinancing fees. You might also have to pay more for lawyers, title searches and inspections, too, depending on your situation and lender.

While some of those costs may be absorbed into the new loan, you might have to pay a portion of it upfront. Consider discussing the potential costs with your lender.

4. How Long Do You Plan on Living in Your Home?

You also may want to think about how long you plan to continue living in your home. Some people buy their forever home relatively young and spend the next 20 or 30 years living in it and growing a family. Others might need to move more frequently due to work or family obligations.

That potential time spent in your home can matter when it comes to refinancing. Some experts advise calculating your break-even point — which is the point in time when your monthly savings will cover the costs of refinancing with the new loan. Here's an easy example: Imagine that your closing costs run $6,000, and you save $300 a month on your refinanced mortgage. In this case, your break-even point is 20 months from the beginning of your new loan.

If you plan to move before you hit that break-even point, then it might not make sense to refinance your home.

The Bottom Line

When it comes to refinancing your home, it's usually not an easy decision. However, understanding how the process works and what potential costs are involved can help you determine if it makes smart financial sense for you.

 

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