Continually low mortgage rates offer many homeowners the chance to lock in better rates and lower their monthly payments by refinancing. In other words, a mortgage refi can be a good way to free up money for other important expenses or to grow your savings.
Homeowners who refinanced their 30-year fixed-rate home loans in 2020 will save an average of $2,800 per year, according to mortgage purchaser Freddie Mac. With rates hovering around 3%, homeowners who refinance now may be able to save a similar amount, depending on their current rate as well as the age and size of their mortgage.
However, refinancing a mortgage takes time. It took an average of 53 days to close on a refinance loan in April, according to ICE Mortgage Technologies. That’s one day longer than in March and 14 days longer than April of 2020. The sooner you get started, the sooner you can start saving on your monthly loan payments.
Follow these seven tips to help you start the refinance process.
1. Set a refinancing goal.
Most homeowners refinance in order to get a lower interest rate and, as a result, reduce their monthly payments. However, that’s not the only reason to refinance.
Different loan types offer different advantages.
You may want to switch from an adjustable-rate mortgage to a fixed-rate mortgage to guarantee a permanently lower rate. Maybe you want to switch from a 30-year loan to a 15-year loan to pay off your mortgage faster. If you have enough equity, you may also be able to save on mortgage insurance by switching from an FHA loan to a conventional mortgage.
Perhaps you’ve recently run up against major medical bills, unexpected home repairs or other expenses that are weighing you down financially. If you’ve built up enough equity in your home, a cash-out refi will not only let you refinance your loan but also take out extra cash.
Knowing what you want to accomplish with a refi will help you determine the type of mortgage product you need. Consider all the options to see which works best for you.
2. Check your home equity.
You may be able to qualify for a conventional refi loan with as little as 5% equity in your home, according to Discover Home Loans. However, most lenders prefer you have at least 20% equity.
If you have more home equity, you may qualify for a lower interest rate and lower fees, as lenders will view borrowers who have higher equity as less of a lending risk. More equity also means that you are less likely to end up owing more than the home is worth if home prices fall.
To get an estimate of your home equity, subtract your current mortgage loan balance from your home’s current market value. The result will be your home equity. Contact a knowledgeable local real estate agent to get an idea of your home’s value. Zillow’s home price estimate can also be a good rough starting point too.
You should also prepare your home for an official appraisal, which will be part of the refinance application process. Have documentation about any improvements you have made to the home handy. (For example, did you add a bathroom or replace an old roof?) It won’t hurt to clean and organize your home to get it in showing condition.
3. Check your credit score.
Before making any loan decisions, it’s important to check your credit score, as well as your credit report.
Your credit score will in large part determine how favorable a rate a lender will offer. The higher your score, the lower the rate you’ll qualify for and the lower your monthly payments will be. If you have a low score, look for ways to improve your credit score well before applying for a loan.
Your credit report shows the information your score is based upon. It’s where you can check if there are any errors that may be negatively affecting your credit score. If you find mistakes in your report, you can contact the credit bureaus to have these items removed. Be prepared to provide documentation proving the mistake.
As part of the consumer protections put in place by the CARES Act, you can get a free weekly credit report from any of the major reporting bureaus through April 2022. (Typically, you’re entitled to one free report from each credit reporting company per year.)
You should also be aware of what factors could cause a temporary hit to your credit score. Applying for credit cards, personal or auto loans just before, at the same time, or just after applying for a refi will lower your score, albeit temporarily.
4. Do the math to see if refinancing will pay off.
Before applying for a refi, make sure you understand the costs associated with a new loan. Refinance closing costs typically run between 2% and 5% of the total loan amount. For a refi to make sense, you have to be able to recover these closing costs, as well as save money over the long term.
To determine if it’s worthwhile, you’ll need to calculate your break-even point. This refers to how long it will take for the savings from the new loan to surpass its cost. You can calculate the break-even point by dividing the closing costs of the loan by the amount of money you save every month.
For example, if your closing costs are $5,000 and your monthly savings are $100, your break-even point would be 50 months or about four years. In this case, refinancing probably makes sense if you plan on living in your home longer than four years.
An easy way of figuring out if a refi is right for you is using a mortgage refinance calculator.
5. Get your mortgage paperwork in order.
Even with recent advances in the online application process, you’re still going to need a lot of documentation that proves your financial readiness to refinance.
The documents you should have handy include your latest pay stubs, the last two years of W-2s, information about your current home loan, as well as information on property taxes and home insurance.
If you’re self-employed or have a non-traditional job, have two years of bank statements available. You may also need a profit and loss statement from your bank, the last two years of 1099 forms and client invoices as proof of income.
A lender may have additional documentation requirements depending on their initial assessment of your finances. Once you have decided on a lender, find out about any other requirements so you can get it together ahead of time. Doing so will make the application process a lot smoother.
6. Shop around for a mortgage lender.
Don’t just take the first interest rate you’re offered. You should compare rates and terms from at least three different lenders to see which one offers the best package for your needs.
You should also consider different types of lenders. Compare rates from big banks as well as online lenders and local credit unions. If you have a long-standing relationship with a financial institution that also offers home refinancing, check with them as well. You may be able to negotiate a better rate if you already have other financial dealings with the lender — but not always. Don’t assume the lender you know is giving you the best deal.
7. Lock in your rate.
Once you’ve found a lender that offers the terms and rate that best suit you, lock in your interest rate.
Though still very low, mortgage rates have been trending higher since the beginning of the year. A rate lock will ideally guarantee that your interest rate won’t increase before closing.
However, rate locks are typically made for 15-to-60 day periods. With lenders taking a while to close these days, you may want to opt for a longer lock. While some lenders may not charge for a rate lock, others will. Rate lock fees can vary between 0.25% to 0.50% of the total loan amount. If your loan doesn’t close in time, extending the lock period can lead to additional fees.
The key with a rate lock is timing. Consult your lender to find out how long they typically take to close, then lock the rate for that amount of time.
A note about mortgage forbearance.
If you’re struggling to make your mortgage payments as a result of the COVID-19 pandemic, seeing if you qualify for a loan refinance can be a good first step.
Refinancing your loan could bring your mortgage payments within your budget. However, if refinancing isn’t an option because you don’t have enough income or your credit score has taken a hit, then consider requesting a payment forbearance from your lender.
Extended as part of the CARES Act, forbearance allows homeowners to pause their mortgage payments for an initial six-month period. If conditions do not improve within that time frame, up to two six-month extensions can be requested. The deadline to request forbearance has been extended several times, with the latest extension ending on September 30th.
The paused payments do not go on your credit report as late payments, and forbearance doesn’t negatively affect your credit score, but the fact that you requested a pause in your payments does go on your credit report. Potential lenders can see this information and that can affect your desirability as a borrower.
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