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These days, making the decision to refinance can be somewhat intimidating. Does it really make sense? Will I even qualify? How much money can I really save? Sometimes it is easier to take a step back and start from the beginning.
In basic terms, when you refinance your mortgage, you are simply replacing it with a brand new loan. You should expect to go through a mortgage application process similar to what you experienced with your original mortgage. Refinancing can be a great financial option because it may provide the following benefits:
The majority of skeptics are simply unsure as to whether they qualify, since banks are always trying to assess the level of risk associated with lending money in each situation. While the mortgage industry is constantly changing, there are always three main criteria used to evaluate whether a person qualifies for a refinance: credit, income, and equity. It can be extremely beneficial to conduct a brief self-assessment on these three criteria before you apply.
Let's start with credit. In order to begin the process of determining whether you qualify, mortgage lenders will obtain a copy of your credit report, which contains credit scores from all three major bureaus (Experian, Equifax, and Transunion). Most banks require a median score of at least 600 in order to qualify for most refinance programs. Usually the higher your score, the lower the interest rate you will receive, so it is extremely important to monitor your credit. To be proactive, obtain a free copy of your credit report before applying to refinance, so that you have a chance to correct any errors that could be negatively affecting your score. Under the Fair and Accurate Credit Transactions Act, you are entitled to a free copy of your credit report once a year. To get a free copy of your credit report, visit www.annualcreditreport.com, and check out our article that covers Your Right to Know What's in Your Credit Report.
Information pertaining to your income is usually obtained by reviewing recent paystubs, W2 forms, and tax returns. While you should be keeping files of these documents anyway, it is very important to have them accessible as you go through the refinancing process. The bank will determine your overall debt-to-income ratio, which is the percentage of your monthly gross income that goes toward paying debts, by combining the existing monthly debt obligations on your credit report with your new mortgage payment, and dividing it by your monthly gross income. This will help the bank determine your ability to repay your new loan.
Equity in your home is defined as the current market value of your home minus the outstanding mortgage balance. Home equity is essentially the amount of ownership that has been built up by the holder of the mortgage through payments and appreciation. The more equity you have, the lower the interest rate you will receive. In order to research your home's appreciation, find out what similar homes on your street or in your neighborhood have sold for in the last six months by visiting sites such as trulia.com and homes.com. This should provide you with a good idea as to what value your home will appraise for.
Once you have found out whether you qualify, the next step is to make sure that refinancing makes sense for you. You can determine this by obtaining estimates from several different banks or lending institutions to make sure you are getting the best deal. As a general rule, it usually makes sense to refinance when you can lower your interest rate by a full percentage point. This should, however, be treated on a case-by-case basis, as depending on the loan amount and the situation, it can still make sense to refinance even if your rate is being reduced by less than a percentage point.
One easy way to determine the benefit to you is to conduct a break-even analysis. Simply verify your closing costs from the estimate you received and divide this number by your monthly savings, which is determined by subtracting your new mortgage payment from your current mortgage payment. The number you are left with is the amount of time, in months, it will take to breakeven, or the number of months you would need to remain in your current home before you have recouped all of your costs. For example, if the closing costs totaled $3000 and monthly savings from refinancing would be $200 per month, divide $3000 by $200 to determine that it will take 15 months in order to recoup your closing costs and breakeven. In other words, this refinance appears to make sense provided that you stay in your current home for over 15 months. This simple exercise can be very helpful when you are looking into refinancing for the purpose of lowering your rate and your payment.
Currently, rates are at historic lows, so if you are thinking about refinancing, now is definitely the time to inquire in order to take advantage of these low rates. Choosing a lender can be as simple as selecting the lender that offers the best mortgage terms, but it is always safest to go with a referral, especially if you know someone who had a very positive experience with a specific mortgage banker. Good customer service and a glowing testimonial can go a long way in securing new business and instilling confidence in new clients.
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Before the housing bubble burst, many people achieved the American dream of home ownership. However, the way in which these dreams became a reality wasn’t always ideal, as unknowing consumers accepted risky mortgage structures or even mortgages they ultimately couldn’t afford. So when the economy tumbled and millions watched their home values similarly plummet, many people missed making their mortgage payments or simply struggled to find the money needed to make those payments on time.
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