Most homeowners consider the major financial decision of refinancing their home at some point during their lives. When done wisely, refinancing can be used to secure better terms for your mortgage, lower your monthly mortgage bill, build equity faster, or tap into existing home equity to cover large expenses.
But refinancing isn’t right for every situation. Depending on your current mortgage interest rate and other variables, the long-term savings of a refinance may not justify the up-front cost. No matter what your refinancing goals may be, homeowners should approach this process carefully to make sure a mortgage refinance improves their financial outlook.
If you’re thinking about refinancing your home, do your research before you fill out an application with a lender. Here are five things to keep in mind as you consider this process.
1. Determine your primary goal.
Refinancing can be an extremely valuable financial tool—but given the cost and financial implications, it needs to be used wisely. If you are interested in a refinance, you should have a clear goal you hope to achieve through this process. Otherwise, you risk going through a complex and expensive process that will hinder your financial progress and could even increase your debt.
If you’re hoping to adjust your interest rate or repayment length, for example, make sure the long-term implications justify the short-term costs. With interest rates, refinancing only saves you money if you can reduce your interest rate by 1-2 percent.
If you’re hoping to tap into equity through a cash-out refinance, have a plan for how that money will be used. Home improvements, investments, and even debt consolidation are all excellent choices. Just make sure you don’t pull out cash to spend on vacations or luxury goods.
2. Decide if you want to cash out equity during your home refinance.
Some homeowners may be motivated to refinance their home to secure better interest rates or loan terms. Even if a cash-out refinance isn’t your primary goal, refinancing is a good time to take out some of this equity and put it to other uses, such as a home renovation project.
The amount of equity available will depend on your home’s appraised value. You can use calculators and home value estimators to reach a rough estimate of how much equity you have at your disposal. You can always borrow against your home equity in the future, but a second mortgage or home equity line of credit (HELOC) will bring additional costs you can avoid by cashing out during a refinance.
3. Refinancing can help you cancel private mortgage insurance (PMI)—but it isn’t necessary.
When your home is appraised during a refinance, increased value of the home—in combination with equity built up through timely mortgage payments—can lead to enough equity that you are able to cancel private mortgage insurance (PMI).
This is a great benefit of doing a refinance, but it shouldn’t be your sole reason. Your lender can arrange for an appraisal that verifies your amount of equity in the home and eliminates PMI without undergoing a refinance.
However, if you are going to pay for the cost of an appraisal for PMI, you might benefit by folding this cost into the cost of a total mortgage refinance.
4. Pre-approval can help you lock in a low interest rate.
You’re likely familiar with the pre-approval process from your initial home purchase. Pre-approval is a smart tool to help you lock in a low interest rate for a set period of time—typically 60-90 days. Even if rates go up during that time, you can keep the lower rate you were given during the pre-approval process, which saves you money in the long run.
If rates are low but you aren’t certain you want to refinance your home, one option is to get a pre-approval and then use the extra time to make your decision without the pressure of a possible interest rate hike.
5. Clean up your home before the appraisal for your refinance.
A home appraisal isn’t just important when selling a home. For refinancing, it can also determine how much equity you can tap into and whether you’re able to get rid of PMI.
Before your appraisal, take time to clean up your home, declutter, and even beautify the front of your home. These small changes can lead to a better valuation.
Refinancing is a valuable financial tool for homeowners, but it’s also a big decision that must be approached carefully. Learn more about the benefits and risks of refinancing your home—download The Smart Homeowner’s Guide to Refinancing today.