Refinancing, meaning the trading of an old mortgage for a new one, is a common practice to lower the monthly payments and interest rate. When you refinance, meaning, trade the old debt, the bank or the lender will clear off your past loan and provide you a new one with updated terms. Many people decide on refinancing their mortgage, so what should you know before refinancing your debt?
Shutterstock
Refinancing your mortgage does not necessarily mean that you’re making the right decision or that it will save you some money. There is a definite refinancing risk involved. Thus, there are some things you must know about refinancing before you make this decision, such as:
- Know your credit score
Over the past few years, lenders have made a few changes in their loan approval terms. Consequently, at times, consumers might get surprised that they do not qualify for the lowest refinancing rate, despite having a great credit score. Typically, lenders require you to have a credit score of 760 or more to qualify for the lowest mortgage rate. If you are a borrower with a low credit score, you may still be eligible for refinancing, but your refinancing rate might be slightly higher. - You may not always save money
Given the high upfront cost involved in refinancing, there is a certain degree of refinancing risk involved. So, whether you end up saving money or not depends on a variety of different factors, including the interest rate you are offered and how long you intend to stay in your home. Let us give you a refinancing risk example. You owe a lender $250,000 on a 30-year fixed home mortgage, taken at a 4.8% interest rate for a house purchased in 2011. You then decide to refinance the loan by getting a new 30-year fixed home mortgage, this time at a rate of 3.6%. This settlement requires you to pay $6,000 as a refinancing fee.
When you decide to refinance the loan, you can save $175 per month in your mortgage payments. This can break even in only 35 months. Sounds good, right? Now, let us take a flip side of this refinancing risk example. What if the home mortgage that you availed in 2011 bore an interest of 4%? In this case, the mortgage payment cut would be just $57 per month. Consequently, it will take you nine years to break even.Hence, if you do not intend to stay in the financed home for about 10 years, refinancing won’t save you a lot of money. Thus, it is vital to know your savings before deciding to refinance.
Shutterstock
- Debt-to-income ratio
What is the debt-to-income ratio? It is the amount of the monthly gross income as opposed to the debt payments. It is a vital factor that is taken into consideration when establishing your qualification for a mortgage loan. For someone who has taken several loans, refinancing the initial mortgage loan may be a little complex.
