What Questions to Ask When Refinancing a Mortgage

Refinancing a mortgage can help you achieve important financial goals. It involves getting a new loan to pay off your existing mortgage, changing your loan terms in the process.

Getting a new home loan is a major financial decision, so you should ask yourself a few key questions before refinancing your mortgage. This will ensure you understand refinancing costs, whether your new loan will reduce your total and monthly costs, the impact of lowering your interest rate, and what your break-even point is for refinancing.

6 Refinance Questions to Ask Yourself Before Refinancing

Here are six questions to ask yourself before you move forward with refinancing your mortgage loan.

1. What Is My Refinancing Goal?

Your goals for refinancing may vary depending on your financial situation.

For example, you may want to access equity to get cash out of your home to consolidate debt, cover medical or education expenses, take advantage of other investment opportunities, or improve your home. A cash-out refinance loan can be an affordable way to access funds to afford these types of big financial goals.

Alternatively, you may want to refinance simply to change the details of your loan. Maybe your financial situation has changed, and you’re able to change to a shorter loan term to pay off your mortgage faster, or you may want to reduce your rate or get a longer loan term to lower your monthly payment even though the total finance charges may be higher over the life of the loan.

2. Do I Qualify for a Refinance?

You must meet refinancing requirements in order to refinance. Here are some of the factors that affect whether you will qualify for a new home loan to pay off your existing mortgage:

• Home equity: You must have home equity to refinance. Equity is the difference between the value of the home you own and the outstanding balance of the loans you have on the home. Many lenders require you to limit your total loan balance after you refinance to 80% to 90% of your home's value. If you do not have at sufficient equity, you may not be able to move forward.
• Credit score: Lenders typically set a minimum credit score requirement for cash out refinances. For a conventional cash out refinance, you may need a minimum score of 620 to 640, while an FHA or VA cash out refinance may require a minimum score of 550.
• Debt-to-income ratio (DTI): Your debt-to-income ratio (DTI) is your debt relative to your income. It is common for lenders to cap your total debt payments (including your new refinance loan) at 36% to 43% of your income.

3. Should I Do a Rate-and-Term Refi or Get Cash Out?

Refinances have different goals. A rate-and-term refinance is done primarily to change your payment and interest costs compared with your existing mortgage. You can refinance to lower your interest rate or make your repayment term longer or shorter.

A longer repayment time can mean higher total costs but lower monthly payments, while a shorter term means lower costs over time but higher payments each month.

You could also do a cash out refinance if your primary goal is to get equity out of your home. Your mortgage loan balance will increase by the amount you take out in cash plus the costs associated with the new loan but you will walk away with the money you need for your other goals.

4. Can My Current Lender Offer a Better Rate?

If your current lender can offer you a better rate than you have on your existing loan, this can sometimes streamline the refinance process.

However, you don't want to refinance with your existing lender without shopping around first to make sure you're getting the most affordable loan. Pay attention to interest rates, closing costs, and repayment timeline when you decide which lender to work with.

5. How Long Do I Plan to Live Here?

Refinancing comes with upfront costs. If you don’t plan to live in your home for at least a few years after refinancing, it’s usually not worth paying the costs of getting a new loan.

6. How Will a Refinance Impact My Monthly Payment?

Refinancing can sometimes lead to a higher monthly payment if you shorten your loan term. This is true even if you reduce your interest rate since you are paying back the debt more quickly. However, a shorter term will allow you to save on interest over the life of the loan.

If you refinance to a loan with a longer term, this will likely reduce your monthly payment -- especially if you also lower your interest rate. However, when you pay debt for more years, the total finance charges may be higher over the life of the loan, even if you did lower your rate. Consider whether you'd rather pay less each month, or over time.

A refinance calculator can help you compare the monthly and total costs of different loan options so you can make an informed choice.

6 Questions to Ask a Lender Before Refinancing

In addition to asking yourself questions before refinancing, there are also some key questions you should ask your lender.

1. What Is the Break-Even Point?

The break-even point is the point where you recoup the upfront costs of refinancing. You need to know this so you can determine if you are likely to stay in the house for long enough to break even.

As a simple example, if you save $100 per month and pay $3,000 up front in closing costs, you would break even in 30 months. If you plan to move or refinance again, refinancing might not make sense. It’s also important to consider the total cost of borrowing as, by refinancing, the total finance charges may be higher over the life of the loan.

2. What Is the Annual Percentage Rate (APR)?

When you compare new mortgage loan offers, you need to look at both APR and interest rate. Your annual percentage rate (APR) includes not just interest costs but also fees that you are charged for your refinance loan. APR is often a better representation of the total amount you pay for borrowing than the interest rate is, as it includes all the expenses you incur.

3. How Much Will the Total Closing Costs Be?

Refinancing costs can total between 2% and 5% of the loan amount, which can be several thousand dollars. These costs may include things like an appraisal fee, application fee, and origination fee.

Make sure you can afford the costs of refinancing and that the break-even point isn’t too far down the road. You should also compare costs among lenders when choosing which loan is the best option.

4. Will I Have to Pay Private Mortgage Insurance (PMI)?

Private mortgage insurance is required for certain types of mortgage loans if your down payment or home equity is less than 20%. PMI adds costs to your monthly payment, so find out if your lender will require you to incur this extra financial burden.

5. Is the Loan a Fixed or Adjustable-Rate Mortgage?

You have the option of choosing between fixed-rate and adjustable-rate mortgages (ARMs). ARMs often have a lower starting cost compared with a 30-year fixed-rate loan, but they come with less certainty because your rate can change over time. Fixed-rate loans provide a guarantee your payment won't change over the life of the loan.

In some cases, you may want to refinance an ARM to a fixed-rate loan if you are worried interest rates will go up.

6. Are There Prepayment Penalties?

Some lenders charge prepayment penalties when you pay back your loan early. Ask if your lender does. You may want to avoid a lender that charges these fees if you are thinking of paying your mortgage off ahead of schedule.

Refinance Loan Options to Consider Next

There are different types of mortgage refinance loans to consider when deciding whether to refinance. After you have determined if you want a rate-and-term or a cash out refinance, you need to decide which loan is right for you.

In addition to conventional cash out refinances, other refi loan options that allow you to get cash for your equity include:

• VA Cash Out Refinance: A VA Cash Out Refinance allows eligible veterans to access their equity while getting a new loan backed by the Veterans Administration.
• FHA Cash Out Refinance: An FHA Cash Out Refinance allows homeowners to get a new loan that is guaranteed by the FHA.

In addition to conventional rate-and-term refinances, other refi loan options that can offer improved terms or lower rates include:

• VA IRRRL Streamline Refinance: A VA Streamline Refinance (VA IRRRL) allows you to refinance to a new VA-backed loan to lower your rate while reducing the upfront administrative burden and costs of a refinance.
• FHA Streamline Refinance: An FHA Streamline Refinance makes it faster and simpler to get a new FHA loan with a lower interest rate to replace your existing FHA loan.

Final Thoughts: Answering Your Refinance Questions

Refinancing your mortgage is a major financial decision and you must make sure you go into the process informed and find the right refinance loan.

Asking yourself these questions, and asking key questions of your lender, can help you ensure you're making the right choice. Reach out to Freedom Mortgage today to understand your refinancing options and find a loan that's right for you.