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10 Things to Know Before Refinancing Your Home Part 2

Wednesday, July 15, 2015   /   by Ken Couture

10 Things to Know Before Refinancing Your Home Part 2

When making the decision to refinance it pays to shop around online for the company that will best suit your needs. There is some competition out there between refinance companies which gives you a bit of an edge if you leverage it correctly, you may be able to negotiate a great interest rate and terms that suit your circumstances perfectly. Much of the application process can be completed online with a secure website where you can upload documents and information. The process can seem daunting when you first start filling out applications and getting lists of items the company will need. Take it step-by-step, ask questions when you are unsure of something and it will all come together. The process takes time, usually several weeks before closing is finalized, try not to get discouraged. 


Debt-to-Income Ratio


Debt-to-income ratio is a very important number, nearly as important as your credit score when it comes to refinancing. Lenders want to see a low debt-to-income ratio in order to lessen their risk that you could default on the loan. This ratio includes all of your monthly debt compared to your total gross monthly income.


Lenders will consider your debt-to-income ratio before agreeing to refinance your home. Your new mortgage payment, all inclusive, must be less than 30% of your gross monthly income and your overall debt must amount to less than 40% of your gross monthly income. Calculate your debt-to-income ratio.


Second Mortgages and Liens


Carrying a second mortgage on your home complicates the refinancing process. Refinancing pays off your first mortgage which moves the second mortgage holder up to first place in the payoff queue.  If you have a home equity line of credit, the holder of that note must agree to move back to second place.


The other option is to pay off the second mortgage before refinancing, if this is possible it is ultimately the best option. Many second mortgage holders are not willing to stay in a secondary position for a new mortgage. If you have good equity and are doing a cash out refinance, you could agree to pay off the second mortgage with the proceeds.


Loan Types


There are a variety of loan types available. Before you refinance your home, determine the type of loan that best suits your current and future needs. If you plan to stay in your home long term and you are still younger, refinancing for a 30 year mortgage could drastically reduce your payments.


The other types of loans are cash-out refinance, where you have enough equity to get a payout at closing because you are borrowing the full value of the home. Cash-in refinance means that the homeowner pays cash at closing, this happens when there is negative equity or they want to avoid a higher interest rate. Lastly, there are government refinance loans that allow the homeowner to borrow up to 125% of the home's value.


Timing


When considering the type of refinancing loan that is right for you, also factor in your timing. Do you plan to own your house for another 15 years? 30 years? Less? If you are turning your house around quickly, you may consider an Adjustable Rate Mortgage or ARM.


An issue that no one likes to bring up is your age, when you are choosing a mortgage term you need to think about how long you plan or will be able to stay in your home. If you are already retired a 30 year mortgage does not make sense. But even some younger homeowners choose a shorter 15 year term, just because they do not know if they will stay in their home longer than that.


Tax Implications


In most cases, a person’s home mortgage interest is his largest tax deduction. When you refinance your home, your lower interest rate means you will have a smaller tax deduction. Factor this change into your break-even calculation and make sure to plan for this change so you don’t get any unpleasant surprises on tax day.


If you are taking cash back on your equity, there are limits to what you can deduct for that as well. The IRS allows you to write off the interest on the first $100,000 in home equity debt. You also will be able to write off the first $1million in home mortgage, but remember that when your interest rate decreases so does the amount you can deduct.