Are you ready to refinance your home, but want to make sure you do it in a way that's most beneficial to you - and your wallet?
You're in luck. To help you get started, we spoke to mortgage experts who shared some tips.
Before you jump onto the refinancing path, though, experts warn that refinancing isn't for everyone.
"You have to look at it from the standpoint of: 'How much is it going to cost me and how long until I can recoup those costs? That's the secret to refinancing,'" says Don Frommeyer, president of the National Association of Mortgage Brokers (NAMB).
The good news is, with rates dipping below four percent for a 30-year fixed loan, there's a good chance refinancing could make sense for you, according to the Mortgage Bankers Association's June 12, 2012 "Mortgage Finance Forecast."
So read on for seven tips to follow before you sign on the dotted line.
Tip #1 - Check Your Credit Rating
If you don't know what your credit score is, you might want to find out. Why? Because a bad credit rating could disqualify you from refinancing your home, or result in a higher interest rate on the loan you do qualify for.
"I think everyone should check their credit report once a year," says Frommeyer. "You can do it for free online, and that way you know if anything has happened without you knowing, or if there's something outstanding you forgot about."
Outstanding balances, as well as a host of other credit issues, could lower your credit score and make a big difference when you refinance, says Frommeyer.
Keep in Mind: Lenders typically use the Fair Isaac (FICO) credit score to check an applicant's credit worthiness, says Frommeyer.
- FICO scores range from 300-850 - higher is better.
- Individual lenders may decide their own standards for what's risky and what's not.
- According to FICO, some things you can do to improve your credit score include setting up payment reminders and reducing the amount of debt you owe.
Tip #2 - Know What Your Home is Currently Worth
As you probably know, the housing market fluctuates - sometimes by surprising amounts. And that could be a good or bad thing when it comes to your home's value.
But what does this have to do with refinancing? According to Fred Arnold, a mortgage professional and director of NAMB, it's important to have an accurate idea of your home's worth because the value could affect your loan rate when you refinance.
Generally, the higher the value of your home, the better the rate for the same amount borrowed.
Keep in Mind: There are a few ways to determine the wealth of your home, according to Frommeyer and Arnold:
- Check the assessed value on your most recent county tax statement; it's usually reassessed every few years.
- Get a professional appraisal. (Note: The lender will eventually do this.)
- Check comps (prices of homes similar to yours sold or for sale in your area) on the Internet. (Note: This is the least accurate since no home is exactly like yours.)
Tip #3 - Choose a Short Loan Length, If Affordable
When you refinance, you can opt to switch to a shorter-term loan.
The benefit? When you have a short-term loan, more of your monthly payment goes toward principal (the amount of money you borrow) as opposed to interest (the amount you are charged to borrow the money). When the principal is paid off, no more interest is charged - i.e., the loan is paid off.
So, on a 30-year loan, says Frommeyer, for roughly the first 15 to 17 years, your monthly payment is mostly interest. But in a 15-year loan, after the first five years or so, you will likely be paying more principal than interest with each monthly payment.
"If you do a 15-year loan, in 12 or so years you've got your house almost paid off," says Frommeyer. "It moves so quick."
Keep in Mind: Here are some things to consider about loan durations, according to Frommeyer and Arnold:
- In addition to 15- and 30-year loans, there are 20- and 25-year terms.
- Although your interest rate might be lower with a shorter loan, your monthly payment might be higher because you must pay off the principal, and interest, in a shorter amount of time.
- Make sure you factor in future expenses like home repairs and college tuition for your kids when deciding on the term length. You want to make sure you can afford - and sustain - the monthly payments.
Tip #4 - Shop Rates When Refinancing
Okay, it might not be as fun as shopping for a new set of golf clubs, but unless you're Tiger, it's probably a lot more important. Why? Because refinancing rates fluctuate from lender to lender.
That said, don't expect wildly different interest rates.
"Rates are the lowest they've been in 50 or 60 years," says Frommeyer. "So [every lender] is going to be within an eighth of a point because it's so competitive right now." Still, an eighth of a point can add up when you're talking about tens or even 100s of thousands of dollars.
Keep in Mind: More shopping tips, according to Frommeyer and Arnold:
- When looking for a mortgage professional, get referrals if possible.
- Always give the exact same information when checking rates so the comparison is meaningful.
- Remember that there are plenty of mortgage professionals and plenty of lenders out there, so make sure you are comfortable before you make a final decision.
Tip #5 - Check for Prepayment Penalties
Let's say you win the lottery a week after you refinance and suddenly feel the urge to pay off that new loan. Okay, that's probably a long shot. But you could decide to refinance again or sell your home in the future. If so, the last thing you want is a penalty for paying off your loan early, which is what a prepayment penalty is.
And there are many types of prepayment penalties you should be aware of, says Frommeyer. Some go away or lessen over time, say, after three, five, or 10 years. Some always remain. It depends on the lender.
But here's the good news: "There are not too many lenders out there who have these penalties," says Frommeyer. So, if you shop around and research carefully, you should be able to find a lender that doesn't charge prepayment penalties.
Keep in Mind: Here are a few things Frommeyer says to keep in mind about prepayment penalty loans:
- Federal Housing Administration (FHA) loans, which are typically for lower-income Americans, carry no prepayment penalties.
- Neither do conventional loans through the Federal Home Loan Mortgage Corp. (better known as Freddie Mac) and the Federal National Mortgage Association (Fannie Mae).
- Be sure to read your loan documents; they must specify any prepayment penalties.
Tip #6 - Don't Automatically Go With the Lowest Rate
There's a reason a Bentley costs more than a Buick. And while the analogy isn't perfect, when it comes to refinancing, you want to consider the features of each loan, not just the interest rate, says Arnold.
For instance, generally, a higher interest rate equals less in closing costs, he says. Closing costs are expenses you incur to get the loan; they include things like home appraisal fees, title searches and insurance, credit report charges, and more.
"That's why it's always worth checking if it makes more sense to go with a little bit higher rate and have less closing costs," says Arnold.
Keep in Mind: Here are a few other tips, according to Frommeyer and Arnold:
- Factor in that more interest means more of a tax break - you can write off interest paid, but not principal paid.
- Generally, the shorter the term of the loan, the lower the interest rate - a 15-year loan usually has a lower rate than a 30-year loan.
Tip #7 - Get a Loan Rate Lock Confirmation
So you've done all your homework and finally decided on which loan you want.
That's great, but you're not done - yet. As a final step, you'll want to "lock" your loan, which guarantees the rate you will get.
This means your rate can't change, even if the market does. When you decide to lock your loan, and by extension, your new rate, you should ask for confirmation of that in writing, says Frommeyer.
"Get a copy of the lock confirmation in case there's ever any question if the lender ever locked it," he says.
Keep in Mind: Here are some important points about locking a rate, according to Frommeyer and Arnold:
- Frommeyer recommends deciding on a rate that you will be happy with, no matter what. Why? Because if rates go down after you lock your loan, you don't want any regrets.
- A reputable mortgage professional always asks you to make the final call on whether to lock a loan. After all, it's your money.