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Thinking of Refinancing Your Mortgage? Check These 4 Financial Areas First

This article is more than 5 years old.

Refinancing your mortgage can be a great way to save on your monthly payment or to change up the terms of your loan. However, while it's a financial move that can help many people, it's not for everyone. If you're thinking of refinancing, do yourself a favor and evaluate these four financial areas first. Doing so can help save you a lot of stress and heartache in the event that refinancing isn't right for you.

Your credit score

Keep in mind that before you have the opportunity to refinance your mortgage, you have to be pre-approved to get a new one. A lot of whether you receive that approval will depend upon whether your credit score is up to snuff for today's standards. These days, you can qualify for a conventional loan with a score of 620 or an FHA loan with a score as low as 540.

If you need to do a little work on your score before you can apply to refinance, don't worry. Talking with a lender is an easy way to find out the best methods to boost your score. However, in the meantime, you can focus on making your payments on time, every month. Additionally, work to pay as far above the minimum payment as possible in order to pay down your debts faster.

Your other debts 

The amount of debt you're carrying is also worth considering. For one thing, your debt-to-income ratio is another factor that mortgage companies look at when they go to approve you for a loan. You can find your ratio by dividing your total reoccurring debt by your monthly income. Ideally, your ratio will be less than or equal to 36%.

That said, if you're planning on rolling other debts, like credit card debt, into your refinanced mortgage, we'd caution you to be careful. Credit card debt is unsecured, meaning that no one can come and repossess anything if you default. The worse that will happen is your score takes a hit.

However, your mortgage is secured debt, meaning that if your new loan is too high and you're unable to keep up with the payments, the bank will come and foreclose on your house. The stakes are much higher in the second scenario so be sure to think it through.

Your savings 

Most people consider refinancing their mortgage in order to save money on their monthly expenses. However, what they don't realize is that doing so comes at a cost. Just like when you originally purchased the home, you'll need to pay closing costs, or any fees needed to close the loan.

Though every mortgage company has a unique fee structure, you could be subject to the following:

  • An Application Fee: Most mortgage companies charge a small fee to help cover the cost of processing a new loan application.
  • An Origination Fee: Loan origination fees are the way in which the loan officer get compensated for working on your transaction. Typically, these fees amount to around 1% of the principal amount of the loan.
  • Points: Discount points account for pre-paid interest that you purchase upfront in exchange for a lower interest rate over the life of the loan. How much you pay will vary by mortgage company.
  • Appraisal Fees: Mortgage companies are only allowed to loan you up to the fair market value of your home. In order to determine the current market value, you'll be asked to conduct an appraisal. Typically, this process will cost a few hundred dollars.
  • Inspection Fees: Although it's not always the case, you may be asked to do a home inspection or another type of inspection. This will also run a couple hundred dollars.
  • Title Search and Insurance: A title company may perform a title search to ensure that you legally hold the rights to the home and that there aren't any liens or judgments against the property.

All told, the closing costs on the loan will probably cost you between 1%-2% of the loan amount. Ideally, you'll have this amount in savings. If not, there are "no closing cost" options available. In that case, your closing costs will be rolled into your mortgage amount. Though, keep in mind that this will raise your monthly payment.

Your break-even point

Your break-even point is the point at which the benefits of refinancing start to outweigh the upfront costs. You can find it by taking the total cost of refinancing your mortgage and dividing it by the amount of money you'll save each month.

For example: Let's say it cost you $4,000 in upfront costs to refinance your mortgage, but you save $2oo on your monthly payment. 4,000/200 = 20. Therefore, you'd have to stay in your home for at least 20 months, or almost two years, before you truly see any financial benefit of refinancing your mortgage.

If you think you're planning on staying in your home for the long-haul, this shouldn't be an issue. However, if you've been thinking of moving sooner than your break-even point would occur, it might be better to look into other ways to defray your monthly costs.