You’re a typical homeowner who has heard about the benefits of refinancing to save more money, consolidate debt, lower payments, shorten your term, etcetera, etcetera.
And maybe in your mind (in theory), it makes sense. Who doesn’t want to keep more cash in their pocket?
But no one really addresses what you should consider before refinancing.
Here are a few (but important) things to consider when you’re figuring out if a refinance is right for you:
1. Equity In Your Home
Home equity is how much of the home you actually own aka the amount of home you’ve already paid for with your monthly mortgage payments or down payment. How much equity you have could be a deciding factor when refinancing.
If you purchased your home with less than a 20% down payment, you would have needed to pay Private Mortgage Insurance (PMI) on top of your mortgage payment.
You could get rid of PMI by refinancing - but you would need to have at least 20% equity in your home or an 80% loan to value ratio to do so.
2. Credit Score
Having a healthy credit score isn’t just for when you purchased your dream home.
3. Length Of Time In Your Home
If doing a cash-out refinance is your goal, there is a length of time in your home requirement you’ll need to consider.
You would also need to consider how long you want to stay in your home - this becomes a factor when you're figuring out if refinancing makes sense.
For example, if you’re planning on relocating to a new state in the next couple of years, would it really make sense to refinance and pull out cash for home improvements?
In this case, an adjustable rate mortgage might make more financial sense. An adjustable-rate mortgage (ARM) usually has a low rate that stays fixed for a certain timeframe - usually the first five, seven or 10 years of the mortgage - before the rate goes up or down depending on the market.
On the other hand, if you plan on staying for 10 years, you could get a lower rate with an ARM that’s fixed and then move before the rate adjusts to the market to save money.
4. Outstanding Debt Amount
Paying attention to your debt-to-income (DTI) ratio is also important when refinancing..
A lender will also take a look at your DTI when you refinance. If your DTI is lower (less monthly debt compared to your income), you’ll have a better chance of qualifying for a refinance.
If you happen to have equity in your home, you could also consider doing a cash-out refinance to consolidate debt and drop your monthly DTI.
It’s always a good rule of thumb to look at your entire financial picture prior to a refinance to ensure you can accomplish your goals comfortably.