Three Questions to Ask before You Refinance Your Home


For many homeowners, there will come a time where the question is raised of whether it would be prudent to consider refinancing your mortgage. The benefits of refinancing can be great, particularly if you want to use potential savings toward other major expenses like paying toward your children’s college education or saving for retirement. The risks, however, can be every bit as great, and they extend up to and include losing your home and financial ruin.

Because refinancing can be a gamble, it is important to be as certain as possible that you are making the right decision for yourself and your family before pulling the trigger. If you are on the fence, the answers to the following questions can help you decide whether refinancing is a chance worth taking.

What do you stand to gain?

In a January 2017 article from Investopedia entitled “When (And When Not) to Refinance Your Mortgage,” two of the major reasons to consider refinancing a mortgage are in order to take advantage of a drop in interest rate and the ability to shorten the term of a loan.

If you are on the fence, the answers to the following questions can help you decide whether refinancing is a chance worth taking.According to the Investopedia staff, where a widely-held belief once maintained that refinancing would only be prudent provided a minimum 2 percent drop in the interest rate, lenders today suggest that a 1 percent decrease in the rate might be enough to consider refinancing. The benefits of reducing your interest rate include increasing the amount of equity built in your home and decreasing monthly payments, helping to both save and generate money for your family over time.

Similarly, changing the rate of your loan to a shorter term is prudent if you want to pay the house off faster and pay less interest in the long run. In an article for ABC News from August 2016, contributor Byron L. Studdard points out that changing from a 30-year mortgage to a 15-year mortgage should serve the purpose of lowering your rate but will increase your monthly payment because you will be paying off the balance on the home at a faster rate. The benefit of this approach, as Studdard notes, includes “potentially freeing up this money for paying expenses during retirement.”

How long do you plan to live in the home?

In a June 2017 article, State Farm’s Simple Insights™ concludes that it is only advisable to refinance a home if you fully intend to live there for more than three years. Ultimately, the goal of refinancing should be to make or save money, and the act of refinancing carries costs of its own up to and including closing costs.

To determine how much time it will take for you to break even on the cost of refinancing, the article recommends “dividing the amount you’ll pay in fees by the amount you’ll save each month. The result is the number of months to break even on your new loan. If you’re going to sell your home before that break-even point, refinancing might not make sense.”

Studdard suggests that it is also a good approach to have some idea of how much you could earn from renting your home out should a sudden life change demand a move. If your new mortgage payment would be equal to or less than the typical rental price for a comparable home in your area, then you may have an extra level of protection should circumstances change.

As Investopedia contributor Amy Fontinelle adds in a November 2016 article entitled “6 Questions to Ask Before You Refinance,” it is impossible to truly know how long you will live in your current home given the unpredictability of life. However, if your best estimate is that you will live in the home beyond the assumed break-even point, then there is a good case to be made for refinancing.

Do you have the credit score?

State Farm draws a direct relationship between your credit score and the interest rate you will be offered in your attempt to refinance, nothing that “a 100-point difference in your credit score could result in thousands of dollars extra in interest payments for a 30-year mortgage, depending on the amount of the loan.”

As such, checking your credit score is imperative before considering refinancing, particularly if you have built up outstanding debt or had difficulties making ends meet since taking out your original mortgage. State Farm recommends getting a credit report from all three reporting bureaus—Equifax, Experian and TransUnion—to get the most accurate picture of your credit score.

Ultimately, the decision to refinance your home is a decision that should be made after considerable research, soul-searching and conversations with your family and financial experts. If you find that enough of the answers to these question point toward yes, refinancing may be the smartest way to go.

 

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