It’s no secret that mortgage rates are at a near-historic low; the national average currently stands at an average of 4.750%. Compare this to current credit card interest rates – which usually clock in at about 15%, and it’s easy to see why many people are choosing to refinance their mortgages and consolidate all their debt into their mortgage. While this may sound like a great idea for anyone – all of your debt consolidated under a low interest rate – there are still many aspects of refinancing that you need to consider before choosing to go this route. Consider the following before applying to refinance your home.
- Home Equity: Your home equity is the amount of money you owe on your home subtracted from the total appraised value of your home. Unless you want to pay PMI (private mortgage insurance) on top of your monthly costs and interest rates, you need to have at least 20% equity in your home before you refinance. Following the Recession, the decrease in home value has left many homeowners underwater, meaning that they owe more on their homes than their homes are worth so many people have no equity at all. If you don’t have 20% equity, you’ll still have to pay the PMI, but home equity between 10%-15% should be sufficient to qualify you for most refinancing.
Credit Score: Gone is the time when any Joe Shmoe could walk into a bank, apply for a loan, and be approved. Now you need a good credit score if you want to be approved for a good loan; a credit score below 700 may cause you some difficulty in finding a lender who will be willing to offer a mortgage, while the best deals are reserved for those with credit scores above 740. Unless you’re decently certain that your score is good enough to qualify, you probably should wait to apply considering the non-refundable up-front fees of applying for a mortgage that usually totals several hundred dollars.
- Debt Ratios: Not only have lenders become more strict on credit scores, they’ve also raised the bar for debt-to-income ratios. While it’s beneficial to have a high income, a stable or long job history, and substantial savings, what lenders usually want is to keep your mortgage payments at a maximum of 28% to 31% of your gross monthly income. It’s generally a good idea to keep your totally debt-to-income percentage below 36% and, if that isn’t feasible for you, consider paying off some debt before you attempt to refinance to help you qualify.
- PMI (Private Mortgage Insurance): If you have less than 20% equity on your home when you look to refinance, and you aren’t already paying PMI on your current loan, you will be required to pay PMI, or private monthly insurance. If you need to begin paying a PMI on your refinanced mortgage, make sure that money you’ll save by refinancing is enough to offset the additional cost of PMI, or it might not be wise to refinance.
- Refinancing Costs: It usually costs between 3%-5% of the loan amount for a home refinance. However, there are several ways you can reduce or consolidate these costs. Some lenders will offer what’s called a “no-cost” refinance, where – instead of the closing costs – you’ll pay a higher interest rate to cover them. Shop around for all your different options, keeping in mind that sometimes these refinancing fees can be reduced or paid by the lender.
- Rate vs. Term: If you’re considering a home refinance, it’s important to establish your long-term goals for refinancing. While many people are focused on the interest rate, your long-term goal will determine what type of mortgage you need to meet your needs. If you want your monthly payments as low as possible, you’ll want a loan with the lowest interest rate for the longest term. If your goal is to pay less interest overall, you’ll want a loan with the lowest interest rate over the shortest amount of time. If your goal is to pay off your loan quickly, you’ll want to find a loan with the shortest terms with payments you can still afford.
When looking to refinance your mortgage, it’s important to remember also that refinancing will not erase debt. Rather, refinancing restructures your debt to be more manageable under a different set of terms.