Refinancing 101: The Do’s and Don’ts of Mortgage Refinancing
It can save you thousands of dollars. But it’s important to safeguard against the traps and pitfalls that come with refinancing your mortgage.
With rates at record lows – and before they go up – you may be feeling pressure to refinance your mortgage.1 While low interest rates are tempting, the decision to refinance is serious with many factors to consider.
People generally refinance to reduce their interest rate, lower monthly payments, or tap into their home’s equity. Others refinance to pay off their loans faster, dispense with mortgage insurance, or switch from an adjustable-rate to a fixed-rate loan.
Mortgage refinancing lets you save money or tap into equity.
Before you begin, consider why you want to refinance your mortgage:
- Do you want to reduce your monthly payment? You can accomplish this by refinancing into a loan with a lower interest rate or you can extend the term of your loan – for example, from 15 years to 30. The drawback to extending the term is that you pay more interest in the long run.
- Would you like to tap into equity? Known as a cash-out refinance, you can borrow more than you owe on your current mortgage, and use the difference to fund something else. You may be able to secure a cash-out refinance and a lower interest rate at the same time.
- Can you pay off your loan faster? When you refinance your mortgage from 30 years to 15, you’ll pay considerably less interest over the life of the loan. Although this can save you a significant amount of money, it will also raise your monthly payment, so it’s critical to make sure you can meet a higher monthly mortgage obligation.
- Are you paying mortgage insurance? Once you have accumulated enough equity in your home, refinancing may allow you to eliminate payments for mortgage insurance.
- Are you looking for the stability of a fixed-rate loan? Refinancing from an adjustable rate mortgage to a fixed-rate loan can provide financial stability and the peace of mind that comes with steady payments, particularly if you believe interest rates will rise. A fixed-rate loan may be a good option if you plan to stay in your home for many years.
If you do decide to refinance:
- Make sure you’re a qualified candidate. Home equity of at least 20% will make it easier to qualify for a new loan. Ideally, you should have a credit score of at least 760 and a debt-to-income rate of 36% or less to qualify for the lowest mortgage rates.2
- Look beyond the rate. When comparing lenders, compare rates and fees. Seemingly low interest rates are often attached to loans with high fees. Before applying, be sure to inquire about origination fees, points, and credit and processing fees. Consider all the costs you’ll incur in refinancing your mortgage.
- Calculate your break-even. Use a mortgage calculator to calculate your break-even—the point at which your accumulated monthly savings will exceed your refinancing costs. If you don’t plan to stay in your home for many years, you may find that refinancing won’t pay off. Be sure you factor all closing costs into your break-even analysis.
- Evaluate adjustable rates carefully. Adjustable rate mortgages can be risky. Tempting as a low initial rate might be, rates on these loans can fluctuate frequently, potentially making your mortgage unmanageable down the road.
- Review your loan documents carefully. Carefully research and adequately understand all facets of your new loan agreement – including the fine print.
A careful evaluation of your current financial situation, along with your goals and your refinance options is a true safeguard against the traps and pitfalls that could come with refinancing your mortgage.
Learn more about mortgage refinancing with an alumni rate discount.
1Rates as of April 1, 2021.
2“Why Debt-to-Income Matters in Mortgages,” Bankrate.com, November, 2020, https://www.bankrate.com/mortgages/why-debt-to-income-matters-in-mortgages/.