Refinancing your mortgage is an opportunity to reduce home ownership costs. But with so many mortgage products available, it’s easy to get confused on which is right for your situation. Also, refinancing comes with an associated cost, and often it’s not cheap, so do your homework before signing up. Here are some basic facts to get you started.
Credit Score is Still Important
Just as when you first purchased your home, your credit score is still important. The best interest rates are typically offered to those with credit scores at 720 or higher. If it’s lower than that, you’ll pay more for the rate you want. If you have the chance and opportunity to raise your credit score, do so before refinancing to help get a better rate. Some of the things that help raise your score are paying bills on time, paying off high interest debt, and monitoring your score to correct any errors.
Define Your Refinance Objective When Choosing Your Mortgage Term
If your objective is to reduce your monthly payment, you’ll likely opt for a longer-term, such as a 30-year loan. The overall amount you pay in interest will be more, but it will help your monthly cash flow. If your objective is to pay less interest overall, you might choose a shorter-term, such as a 15-year loan. The 15-year loan will typically offer a lower interest rate, but since you’re paying off the loan in a shorter time, monthly payments will be higher.
Watch Out for Penalties
Some lenders charge a penalty if you try to pay more than the monthly amount towards your principal. You want the opportunity to pre-pay with a larger amount if you can, so ensure your refinanced mortgage allows this.
Watch Out for No-Cost Refinancing
There are always costs associated with refinancing, sometimes as much as 3 to 5 percent of the loan amount. You can pay closing costs associated with the original mortgage in advance of the refinance, or those costs will be rolled into the entire new loan amount—the “no-cost” version of refinancing. A “no-cost” refinance usually mean you’ll pay a slightly higher interest rate to cover the closing costs. Try negotiating and shopping around since some lenders will pay the refinancing fees or reduce them.
Calculate the Cost of Points When Adding Up Savings
A point is equal to one percent of the loan. So if you borrow $200,000, buying a point will cost you $2,000. Depending on the lender, each point will reduce your interest rate around 0.25 percent, which translates into decent savings over the life of a loan. But if you go this route, plan to stay in your home long enough to break even on what you paid for points. For example, if you paid $2,000 in points and it helps you save $100 per month more than your previous loan, it will take 20 months to recoup your costs. And that doesn’t include any other closing fees you might incur in the refinance. Make sure you do the math.
Your Tax Deduction Could Change
Some people rely on the tax deduction benefit of mortgage interest that comes with home ownership. Refinancing may mean your tax deduction is lower if you’ve lowered your mortgage interest rate. This may not be enough to offset the advantages of refinancing, but it’s still worth knowing.
Like many financial transactions, refinancing can be complicated to understand as there is no one size that fits all. Be sure you work with a reputable lender who will clearly spell out what his or her products do for you as well as your overall costs for the full term of the loan.