What you need to know before refinancing

Are you considering a mortgage refinance? Ask yourself these five questions first.

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Here's the thing: Refinancing a mortgage could save you a lot of money. But, it's no walk in the park, and it definitely is not for everybody.

In fact, there are multiple factors to consider before determining if refinancing is right for you.

"People should always look at the big picture when they are refinancing," says Keaton Hutto, branch manager for Hometown Lenders in Lubbock, TX. Hutto says more often than not people are concerned with how much refinancing is going to save them monthly, and that's a mistake.

Instead, says Hutto, people considering a refinance should ask themselves two questions: "How much is this going to save me yearly?" and "How much is this going to save me over the life of my loan?"

Here are five more questions to ask yourself before you decide to refinance…

Question #1: Is My Credit Score Good Enough for Refinancing?

Remember your credit score? It's that thing you worried about when you bought your first car and home. News flash: It's just as important when you refinance your mortgage.
And the better your score, the better your chance at scoring a low interest rate.

"Any borrower with a credit score of 740 and above can potentially qualify for the best rates," says Dean Vlamis, a mortgage expert at Perl Mortgage, an independent Chicago-based correspondent lender. "There is a price hit to the interest rate at every level, so the lower the credit score, the higher the interest rate."

[Got a stellar credit score? Compare rates from multiple lenders now.]

What if you don't have a soaring credit score? It's not the end of your refinancing road. Your debt-to-income ratio, which looks at your housing payment and other monthly debts, versus your gross monthly income, could be your way out.

"If the ratios fall in line; preferably under 45 percent, then the borrower can get a preliminary approval," says Vlamis.

Question #2: How Much Equity Do I Have?

Before you shell out thousands of dollars to refinance, you should first consider how much equity you have in your home. Equity is calculated by subtracting the total balance of your mortgages from the appraised value of your home.

And the more equity you have, the better your chance of saving money when you refinance. In fact, with higher equity, you'll likely qualify for lower interest rates and fewer additional fees.

"Ideal amount of equity is of course 100 percent [your home is paid off], but what you really want to look at when taking out a loan is hopefully having at least a 20 percent equity position," explains Barry Habib, vice president and chief market strategist of Residential Finance Corporation.

If your equity is poor, don't despair. Habib points out that federal programs such as the Home Affordable Refinance Program (HARP), allows you to refinance with zero equity (or if you owe more than the house is appraised for).

Question #3: Is the Current Rate Climate Good For Refinancing?

If you're looking to refinance today, the answer to this question is "yes."

"Today's rates are close to an all-time historic low," says Malcolm Hollensteiner, director of retail lending sales at TD Bank. "It's easy to second guess ourselves, but rates are so attractive today that it may not make sense to wait for a 'better' future opportunity."

If you purchased a home in the past five years and have not looked into refinancing, Hutto says now is the perfect time to do so.

"You could easily shave off as much as 3 to 4 percent or more off your current interest rate, which will translate nicely to extra cash in your pocket every month," says Hutto.

Question #4: Can I Afford to Refinance?

Refinancing isn't cheap. That's why potential refinancers should consider all costs before deciding to refinance, says Mike Ward, vice president of mortgage lending at Guaranteed Rate, Inc.

According to the Federal Reserve, which oversees national monetary policy and the banks, refinancing costs could include appraisal fees, loan origination fees, application fees, inspection fees, and much more.

"While these fees may seem small separately, they really can add up to a large amount that can alter when you'll actually begin to experience savings from your refinance, commonly called the break-even point," says Ward. 

And knowing your break-even point is key to determining if refinancing is worthwhile. To figure out your break-even point, Ward recommends adding up all refinancing fees and dividing the result by the monthly savings you're expecting from your refinance.

"This number will show you the amount of months it will take to break even," he says.

Question #5: How Long Do I Want to Stay in This House?

Thinking about moving soon? Or do you see a job relocation in your near future? If so, refinancing might not be in your best interest.

"The industry rule of thumb is that if the cost of the refinance (closing costs and points) are made up with the monthly savings within five years, then it is considered to be worthwhile to refinance," says Amy Tierce, a regional vice president for Fairway Independent Mortgage. 

"Of course, the borrower needs to know that they will be staying in the house beyond five years for this formula to make sense," adds Tierce.

However, Tierce explains that if the savings are immediate (because your closing costs are very low, for example), it can be worthwhile to refinance even if you have your heart set on moving out within a short period of time.

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