Refinancing your home loan might save you money, but it’s not the right move for everyone. Before you refinance, do your homework to figure out if it makes sense for your situation and to find the best terms available.
Check Your Credit Reports
Lenders will use your credit history to make a decision, so you should know what’s in your credit reports. Request copies of your reports, check your credit scores, and look for any information that’s incorrect or outdated. Have errors corrected before you apply for a mortgage refinance.
Calculate Your Debt-to-Income Ratio
Lenders set interest rates based on a borrower’s risk. One factor they look at is a homeowner’s debt-to-income ratio, which is the sum of debt obligations (e.g., mortgage, credit card bills, auto and personal loans) divided by gross monthly income and multiplied by 100 to convert to a percentage.
Customers with a higher DTI are considered riskier and are generally charged higher interest rates. If your DTI is high, pay down your debts before you refinance.
Figure out How Much Equity You Have
Your amount of equity will also influence how risky you are from a lender’s perspective. Homeowners who have more equity are considered less risky and therefore qualify for lower interest rates.
Your home equity is your house’s current market value minus your outstanding mortgage balance. To convert that number to a percentage, divide it by your home’s market value, then multiply by 100.
Get Several Quotes and Compare Them Carefully
Shopping around can help you find the best terms available and potentially save tens of thousands of dollars. When you compare quotes, look at each offer carefully and consider all the terms.
A loan that carries a low interest rate but has high closing costs might cost you more than a loan with a higher interest rate and lower closing costs. A loan with a longer term will have lower monthly payments, but you might pay a lot more in interest than you would with a shorter loan term.
Calculate how long it would take you to break even based on the terms that each lender is offering. Divide the closing costs by the amount that your monthly mortgage payments would go down to figure out how long it would take for your savings to equal your upfront cost.
Then think about how long you’ll most likely continue to live in your house. If you won’t stay there long enough to recoup your closing costs, refinancing won’t save you money, at least not according to that particular lender’s terms. The terms that a different company offers might be better for your situation.
Consider your personal goals. If you want to pay off your mortgage before your kids go to college or before you retire, make sure that you refinance to a loan with a term that makes sense for you.
