Low interest rates are driving borrowers to refinance, with applications in 2016 hitting their highest levels for the week ending on Feb. 12, according to the Mortgage Bankers Association.
Refinancing can potentially help homeowners save real money that can be put toward home repairs, consolidating debt or paying off the loan faster. However, borrowers shouldn't go into things blindly. The idea is to improve your overall lifestyle and financial plans, Carlos Jaime, a mortgage planner and owner of CTC Brokers & Associates in Southern California, said.
Here are nine tips to consider before you refinance. (You can also read our mortgage refinancing primer here.)
1. Consider What You Hope to Achieve
"The number one thing you really should consider is what outcome you're trying to achieve," Jaime said. So take a moment to think: Do you want to convert from an adjustable-rate mortgage to one that's fixed? (You can read about their differences here.) Improve cash flow? Remodel the kitchen?
"Once you know what you're doing, you can better decide on the loan that's most appropriate," he said.
2. Consider Your Return on Investment
Borrowers should also consider how long it will take to recover the cost of the loan, Joe Parsons, senior loan officer with PFS Funding in Dublin, California, said. Refinancing involves fees for things such as notaries and document preparation. It also takes time.
"There have been various rules of thumb over the years, most of which are completely bogus," Parsons said, so "the way to ask the question is to really treat it as though it were an investment because it really is."
Another thing Parsons said is key to consider is how much you are actually going to save after covering closing costs. "If at the end of five years, I can calculate I'm saving $6,000, then I can say, 'Am I willing to go through the perceived hassle of doing this to get a net return in my equity of $6,000 at, say, a 5-year time frame?' If the answer is no, they shouldn't do that refinance with anybody," he said.
3. Get an Idea of Your Home's Value
Once you decide to move forward, you should have some idea of your home's value, Parsons said, because it will affect the size of the loan. On average, an appraisal can cost $300 to $400. You may be able to get an estimate by looking your home up on online real estate sites like Zillow.
Another reliable way is to get an Automated Valuation Model (AVM). This computer-generated analysis of a property looks at the same data an appraiser would but not at the actual property. "For anywhere between $12 and maybe $24, a homeowner contemplating a refinance can go to a loan officer who will generally be able to do that," Parsons said. In some cases, she'll even do it for free.
4. Know Where Your Credit Score Stands
Good credit scores generally entitle borrowers to the best terms and conditions on a mortgage, so you'll want to get an idea of where you stand before you start filling out applications. (You can pull your credit reports for free each year at AnnualCreditReport.com and view two of your credit scores, updated each month, for free on Credit.com.)
5. Calculate Your Debt-to-Income Ratio
You should understand your debt-to-income ratio, or DTI, which has your gross monthly income on one side and total debt on the other. Debt can be anything from a new house payment, including taxes and insurance, to long-term debt, such as a credit card balance, student loans or child support.
DTI is expressed as a percentage of gross monthly income, and borrowers can get approval for loans as long as their debt isn't more than 45%. In some cases, a lender may say in order to approve the loan, you'll need to close your accounts and pay them off.
You can find more refinancing tips to consider on Credit.com.
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