Wednesday, July 8, 2015 / by Ken Couture
When you refinance your home, what you are actually doing is simply replacing your current loan with a different one so you can get better terms and a better interest rate. If you have an impeccable credit score and a good history of payments, refinancing can be a profitable decision. On the other hand, a tainted credit history coupled with a lack of knowledge can make refinancing a risky proposition. Mortgage interest rates can fluctuate significantly. When available rates swing lower than your current mortgage rate, there is a strong temptation to refinance your home. Refinancing is a smart option when you can achieve a better interest rate than the one you currently hold.
Some loan institutions charge a sizable payoff penalty when you pay off your original loan early. These penalties can add up, making refinancing a costly proposition. Review your initial loan documentation to determine if there are fees associated with an early payoff.
It is possible to have the penalty reduced or removed if the finance company is willing to work with you. Contact your loan officer, explain that you want to refinance your mortgage, but the penalty hinders the benefits of refinancing. Request to have the penalty removed or reduced. If the loan officer does not have authority, ask to speak to someone who does.
The Cost of Refinancing Your House
Refinancing your home involves upfront payments. Before you decide to refinance, you should understand these associated fees: application fee, title insurance and title search, lender's attorney fees and points and fees. These are all normal fees associated with a mortgage refinance process.
When you are comparing refinancing companies, you want to compare the cost to you. There really is a difference in the final costs of the refinance; you will want to ask for a complete breakdown of fees and costs you will be responsible to pay. If you are cashing out equity, the costs and fees will reduce your payout at closing.
The Break-Even Point
There are always up-front fees associated with refinancing your home. The break-even point is the point in time where the total of these fees—the cost of the refinancing—will be recouped through your lower monthly house payment. While there is no perfect break-even point, when refinancing your home, a good rule of thumb is three years or less.
If you are able to negotiate a true zero-cost refinance, then your break-even point is when you close the loan. If you can get a zero-cost refinance, even if you only save a fraction of a percent on interest and nothing is added to your loan amount, it is wise to refinance. This fraction of a percent could save you thousands of dollars over the remainder of your mortgage.
Your Credit Score
The best refinancing loans are set aside for those with a good credit score, so to get the best refinancing rate, you must have good credit. The major credit reporting organizations offer an annual free credit report, so check where you stand before proceeding. If you do not understand how to read your credit report, you should seek professional guidance. The credit reporting companies have detailed instructions on their website.
If you have any outstanding unpaid debt showing on your credit report, it will need to be paid in full before your mortgage can be approved. This may mean you have to contact creditors in order to satisfy the debt and get a statement of payment. Your loan officer can help you through this process.
The Equity in Your Home
Equity is the difference between the appraised value of your home and your current mortgage balance. Your equity plays into your loan-to-value ratio, LTV, which is a factor in getting your refinance application approved. It also determines whether or not you are required to pay PMI on the new mortgage; if your LTV is 80% or less you should not.
Because the housing market fluctuates, the value of your home fluctuates. If you live in an area of the country where home values are deteriorating, your original home down payment may have dwindled, leaving you with little, if any, equity. Even worse, your mortgage may be more than the value of your house.