Should you refinance your mortgage?


Your mortgage may be one of the biggest and most important investments you make in your entire life – and it can also help you reach your future financial goals. A refinance is a wonderful tool that can help you reach those goals sooner.

Refinancing can allow you to change the terms of your mortgage to secure a lower monthly payment, switch your loan terms, consolidate debt or even take some cash from your equity to put toward bills or renovations. Is it the right choice for you? Here’s a quick reference guide to help you decide.



Why Refinance?

You Need To Change Your Loan Term

Are you having trouble making monthly mortgage payments or are you unsatisfied with your current payment amount? A refinance can allow you to lengthen the term of your mortgage and at the same time lower your monthly payments. For example, you can refinance a 15-year mortgage to a 30-year loan to lengthen the term of your loan and make a lower payment each month.

When you lengthen your mortgage term, you get a slightly higher interest rate because lenders take inflation into account, and a longer mortgage term means you pay more in interest over time. If you know your current payment schedule isn’t realistic for your household income, a refinance can free up more cash so you can invest, build an emergency fund or spend it on other necessities.

You can also refinance your mortgage in the opposite direction, from a long term to a shorter term. When you switch from a longer-term mortgage to a shorter one, you enjoy lower interest rates and you’ll also own your home sooner. Switching to a shorter term also means that your monthly payments will increase, so make sure you have enough stable income to cover your new payments before you sign on for a shorter term.

You Need Cash To Pay Off Debts

If you’ve made payments on your mortgage, you have equity in your home. Equity is the difference between your home’s fair market value and the amount you still owe to your lender. You can gain equity in one of two ways: by paying off your loan principal or by waiting for your home to rise in value over time. If your loan is more than five years old, you’ve probably built a bit of equity in your investment just by making your regularly scheduled monthly payments.

A cash-out refinance allows you to take advantage of the equity you have in your home by replacing your current loan with a higher-value loan and taking out a portion of the equity you have.

For example, let’s say that you have a $200,000 mortgage and you have $50,000 worth of equity – this means that you still owe $150,000 on the loan. You might accept a new loan for $170,000 and your lender would give you the $20,000 difference in cash a few days after closing.

You might also seek a cash-out refinance because you need money to pay off other debt. If you have debts spread over multiple accounts, you can also use a cash-out refinance to consolidate your debts, pay off each account and transition to one monthly payment. Consolidation can help you keep a better record of what you owe and reduce instances of missed payments, late fees and overdraft charges.

You Want To Do Home Improvements Or Renovations

From a broken HVAC system to replacing the pink linoleum in the bathroom, you might need to invest in your home at some point or another. Using the equity in your home can be better than taking out a personal loan or putting charges on a credit card because cash-out refinances usually have lower interest rates than most credit cards.

The average mortgage rate is currently about 4-5% and the average low-interest credit card rate is more than 12%. If you choose a variable rate credit card or a store credit card, you’ll likely pay even more in interest. If you have enough equity in your home to do a cash-out refinance, you can complete your renovations or repairs without excessive interest charges.

Though you can do anything you want with the money you get from a cash-out refinance, it’s important to remember that your refinance is still a loan. It’s a good idea to get estimates from contractors or repair professionals before you close on your refinance. This will lessen the chance that you take out too much money – or you take out too little and have another bill after the job is finished.

You Want To Allocate More To Retirement Saving

One of the most powerful tools that you can take advantage of when it comes to saving for retirement is the principle of compounding interest. The earlier you start to invest and save, the more years you have to accumulate interest on your investments before you retire. If you have equity sitting in your home but you haven’t maxed out your annual retirement contribution limits, you can end up making more money over time by taking a cash-out refinance and investing the difference.

You can also use the money from a cash-out refinance to invest in your property. Whether you want to add a new bathroom, spruce up your paint or install a privacy fence, you’re only limited by your imagination. Upgrading your home can bring in more money over time by increasing your home’s value and curb appeal, both of which can help you secure a higher final closing price if you decide to sell.

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When You Should Refinance

Think you’re ready to refinance? Make sure you meet the requirements to refinance first – and don’t forget to consider home values and interest rates in your area. You might be ready to refinance if:

You Meet the Requirements

Most lenders have certain requirements that borrowers must meet before they can get a refinance approval. Some common lender requirements include:

A Credit Score Of At Least 580

Your credit score is a numerical representation of how reliable you are as a borrower. A high credit score tells lenders that you make your payments on time and you don’t borrow more than you can afford to pay back. A low credit score, on the other hand, communicates to lenders that you’re more likely to have trouble making your payments and you might even default on your loan.

The minimum credit score you need to refinance is 580 for a government-backed mortgage like an FHA loan, but some conventional lenders set their own higher minimum credit scores to refinance. If you don’t have a credit score of at least 580, you can’t refinance until you raise your score.

Debt-To-Income (DTI) Ratio Less Than 50%

Your DTI ratio refers to all of your monthly debts and payments divided by your total monthly income. For example, if you currently pay $1,500 in monthly bills and you earn $4,000 per month before taxes, your DTI ratio would be equal to $1,500 divided by $4,000, or 37.5%. Most lenders require that candidates have a DTI ratio of less than 50% before they approve a refinance.

Your Financial Documents

Just like when you apply for a mortgage, your lender will ask to see a number of financial documents before they approve your refinance. You usually need to have your last two W-2s, your two most recent pay stubs, a copy of your homeowners insurance agreement and your two most recent bank statements before your lender can underwrite your refinance. If you’re self-employed, your lender will probably also ask you for a few more documents to verify your income.

Low Interest Rates

You also want to make sure that you refinance when interest rates are lower. When you refinance, the rate you lock in is comparable to current market interest rates. Compare historic interest rates in your area with your current mortgage rate and talk with a lender about how interest rates will change in the upcoming months or years.

Home Value

If you’re taking cash out, make sure your home is worth more than what you bought it for. This allows you to maximize your equity and secure a lower interest rate. Before you refinance, it’s a good idea to talk to a real estate agent or other local expert or to research on how average property values are trending in your area before you commit to a refinance.