You may have heard that home mortgage rates at the start of 2021 remain near historic lows. This has a lot of homeowners considering a mortgage refinance process to lock in the lowest rates we've seen in years—before they go back up. But before you jump into mortgage refinancing, it may help to take a few minutes to consider these four factors that can impact the value of a mortgage refinance process.
1. What’s Your Goal For the Mortgage Refinance Process?
Refinancing means paying off your existing mortgage with a new one that will replace it, generally with more favorable terms than you enjoyed before. The advantage of the new mortgage will vary, however, as homeowners refinance for different reasons.
One person may refinance to earn a lower interest rate (and therefore reduce total costs), whereas another may be looking to pay off the loan more quickly, reduce monthly payments by extending the loan’s length, or access some of the equity they have in the home for another necessary expense. It’s even possible to “buy down” the mortgage interest rate when it makes financial sense to do so.
Make sure to have your goal clearly in mind before you start looking. This will make it easier to find the best possible refinancing program for your needs.
2. The Size of the Loan vs. the Value of Your Home
Your home’s current value helps to determine your chances of approval for a mortgage refinancing loan. The size of the new mortgage should not normally exceed 80% of the value of your home. The amount of the loan as a percentage of the home’s value is called your “loan-to-value ratio” (LTV).
This ratio is typically discovered with the help of an appraisal of your home’s current value. If the value has fallen since the time that you got your original mortgage, it could mean that you don’t yet have enough equity to start a mortgage refinance process (or would need more cash on hand to make up the difference and improve the LTV ratio).
Some refinancing programs, however, do not require your home to be appraised. Certain FHA (Federal Housing Administration) and VA (Veterans Administration) loans fit into this category. Should you have concerns about a poor appraisal, it may be a good idea to explore a mortgage refinance process through one of these organizations, so long as you are eligible.
3. How Long Will You Stay?
Few people can say for sure exactly how long they’ll remain in a home after signing a mortgage agreement, but the number of years you stay in the home can make a huge difference in the value of a mortgage refinance process. If you do not plan on staying long enough, the closing costs can easily exceed the total number of dollars you’ll save by reducing monthly payments or your interest rate.
Everything really comes down to the “break even” point, or the point in time at which you’ll have stayed in the home long enough for the monthly savings to make up for the closing costs of refinancing. You can figure this out by taking the total upfront cost of the mortgage refinance process and dividing it by your monthly mortgage payment savings under the new loan. For example, if the closing costs of the loan equal $6,000 and the refinanced loan will save you $100 per month on your mortgage payment, it will take 60 months, or 5 years, for you to start saving money on the refinanced mortgage. If you think it’s possible that you’ll move before those 5 years are up, the mortgage refinance process timeline may not line up with your needs.
4. Your Financial Situation (Credit Score, Debt, Income)
When you apply for a refinanced mortgage, the lender will look into a few factors related to your financial situation. Your credit score, total income, and debt-to-income ratio will all have an impact on the lender’s opinion about your ability to make reliable payments.
This means it can be helpful to reduce or eliminate other debts before pursuing a mortgage refinance process. Car loans, credit card debt, or student loan payments all impact your debt-to-income ratio and the theoretical amount of income you’ll have left to pay for the mortgage each month. Lenders often look for your debt to income ratio to be less than about 43%, but this will vary and you should ask about the lender’s policies.
A recent change in work status can also make it harder to get approved for a refinanced mortgage. A stable income is attractive to lenders. It’s usually more advantageous to refinance when you can demonstrate at least a few years of relatively consistent income and employment.