If you are locked in a high-rate mortgage that is affecting your finances, you might have considered refinancing your house However, it is not a miracle solution for everyone. A common misconception is that refinancing your home essentially consists in updating the terms of your real estate loan. It is not: refinancing your mortgage comes down to taking down a new mortgage entirely.
To know if it is the right choice for you, here are a few things you must consider before taking the plunge.
1. How does the terms of your current mortgage compare to your new terms?
Unlike a personal or auto loan, refinancing your mortgage is not free: it comes with closing fees, usually equivalent to 1 to 5% of your new loan amount. For a new mortgage to be worth it, you must consider the difference in interest rate between your new and your old mortgage. How long will it take you to recoup the impact of your closing costs with your new loan?
A rule of thumb is that your new mortgage interest rate should be at least one point lower than your previous rate to be worth it.
How does the terms of your new mortgage will affect your private mortgage insurance? If your house equity has increased during the life of your previous loan, you might not need to pay PMI anymore. However, if the value of your house has decreased, you might need to start paying for a PMI.
Another thing to consider is how far from the break-even point you are in your current mortgage: if you are planning to move at short to medium term, but that you have been paying your current mortgage long enough that your payments go towards the principal of your loan rather than the interest, refinancing might not be an interesting option.
Refinancing can also be an interesting option if you want to change the type of mortgage on your real estate property entirely. If you started with an Adjustable Rate Mortgage, you might qualify for a lower fixed-rate mortgage.
2. Can you qualify for a new loan with better terms than your previous one?
Like for any new real estate loan, your lender will consider several factors before granting you a new mortgage. Don’t hesitate to shop around to see which lender might be willing to offer you more interesting terms.
If your credit score has gone up since you got your old loan, refinancing with better terms might be interesting for you. However, if you have fallen on some hard time and your credit score has taken a hit, refinancing might cost you more. If that is the case, spending some time working on improving your credit score before refinancing will save you money in the long run.
How much equity you have in your house will also be crucial for your lender to decide on the terms of your loan: if the house values in your neighborhood are going down, now might not be a good time to refinance. To qualify for more advantageous terms, you should have at least 20% of equity in your house.
Lenders will also consider your debt-to-income ratio before granting you new terms to your real estate loan, so pay off whichever debt you can before applying for refinancing.
3. What is your goal for your house?
Before refinancing your home, you must ask yourself why you want to apply for a new loan. Getting a lower down payment is only the short answer to a more complex question.
If you are planning to move in the semi-near future, refinancing probably will not save you any money.
Refinancing can be an interesting option if you are trying to pay off your real estate property sooner than later, before retiring for example, refinancing your mortgage from a 30-years term to a 15-years term can raise your monthly payments but will save you money in the long run since you will not spend as much on interest.
Refinancing might also allow you to cash-out on your house equity. However, consider this option carefully before spending this money on your dream vacation, and use it to improve your equity on your house instead.
In conclusion, there is no one-fits-all solution when it comes to refinancing. The best thing you can do before taking this decision one way or another is to meet with a financial advisor who will be able to help you figure out what is the best course of action in your particular circumstances.