Everyone is refinancing! Or at least thinking about it. We all have a friend, or a friend of a friend who saved “a ton” of money on their monthly payments. So is now a good time for you to refinance your home? Well, with interest rates pretty close to record lows then, yes, it may well be.
But, before you take the plunge, you really should consider these five key factors.
- Why are you refinancing? Do you have a plan?
What are you hoping to achieve by refinancing? Maybe you have more disposable income and now want to pay off your home faster. Perhaps you just want to lower your interest rate and reduce monthly payments. Do you want to get rid of Personal Mortgage Insurance PMI payments, or consolidate your credit card debt? Maybe you want to extend the term of your loan or you decided to make some home improvements. These are all valid reasons and refinancing can make sense. Just be sure you understand your goal and approach lenders with a plan. - What is the actual cost of refinancing?
Refinancing can cost anywhere between 3% and 6% of the loan amount. Sure, with a lower interest rate you will be saving on your monthly payments, keep in mind how much it is costing you to switch. Some lenders may offer “no-cost” finance, but that will most likely mean a higher interest rate on the loan. It may be possible to add those costs to the loan itself and therefore just pay them off over the term of your new mortgage. It is worth taking time to work out how long it will take for your monthly savings to cover the cost of the switch. It is also smart to shop around and check what deals are on offer. Also, you don’t necessarily have to accept the initial terms. This is a competitive market where lenders could be open to a reduction in fees.
- How much equity do you have in your home?
As a rule of thumb, you will need to have at least 20% equity in order to refinance. Often people take advantage of the rise in property prices. They now have greater equity in their home and so can get a better interest rate. Also, if you now have over 20% equity you can get rid of your Personal Mortgage Insurance payments (PMI) saving even more cash. Interestingly, according to a report by CoreLogic, from September 2019, to September 2020, homeowners saw their equity rise by 10.8% year over year. - What is your credit score and can it be improved?
So what is your credit score and how will it affect your ability to refinance. Lenders tend to apply stricter criteria these days, where in order to get the best rates you probably need a credit score of 760 or higher. If your credit score is lower, then you can still get a loan, but the rates and even the costs will tend to be higher. There are however a number of ways in which you can improve your credit score. Applying good credit practices over time is the best way to improve your credit score. Paying your bills on time is probably the best thing you can do. Although there are no quick fixes, paying off a large part of any outstanding credit card debt in a lump sum can help, as can. Using less than a third of your available credit limit can also have a positive impact. - How long are you going to be in your current home?
Your break even point is the time it will take you to cover the cost of refinancing through the savings you make from lower monthly repayments . If your break-even point is not too long, and you plan to stay in your home for longer then it makes sense to refinance as you will reduce outgoings and save money over time. If you intend however to move before you have covered the cost or only shortly after then you need to think carefully before refinancing, as it may not be the right option for you at the moment.
