Refinancing your home if you plan on selling it can make sense, but this will depend on your financial situation — it should make financial sense to do so and you should think about what you’ll be getting from a refinance, versus what you’ll be paying. For example, refinancing can give you a lower interest rate and save you money with lower monthly payments. However, you’ll also have to pay closing costs in order to refinance your mortgage. So really the question comes down to: how long do you plan to stay in your home after your refinance and does the refi savings outweigh the closing cos
If you’ll be staying in the home long enough to recoup the costs associated with a mortgage refinance, then it might make sense to go through with that process. However, there are also additional factors to consider such as the impact on your credit score, your ability to qualify for another mortgage, whether there are more cost-effective alternatives, and more.
What are the benefits of refinancing?
A refinance comes in the form of a rate-and-term refinance and a cash-out refinance. Each has its own set of benefits. A cash-out refinance allows you to tap into your home equity to get funding for things like home improvement projects and debt consolidation. Similarly, a rate-and-term refinance can offer better interest rates and lower monthly payments.
Reduces your monthly mortgage payments
As the name implies, a rate-and-term refinance can reduce your mortgage loan payments by either lengthening its term or allowing you to take advantage of lower interest rates. This can help you save money that you can then use to meet your other goals or pay for other types of bills.
Saves on interest expenses
By using a rate-and-term refinance to get a lower interest rate, you’ll be able to save on interest charges. A cash-out refinance can also achieve the same goal, although it typically requires a significant reduction in interest rate because the interest will be calculated off a loan amount that is larger than your previous mortgage.
Builds equity more quickly by reducing your mortgage term
A rate-and-term refinance can be used to shorten the length of your mortgage payment term. A shorter payoff term can also give you a higher monthly payment. This may not seem like a benefit, however, shortening the length of your mortgage payoff means that a larger portion of your payments will be going toward the principal balance of your loan, rather than interest charges. Since you’ll be lowering your mortgage balance more quickly, you’ll be building more equity as well. Additionally, rates on a shorter-term mortgage tend to be lower.
Removes mortgage insurance
If your monthly payment includes mortgage insurance, it is in your best interest to get rid of it as soon as you can. Mortgage insurance does not benefit you as a borrower. It only protects the lender in the event you default on the loan.
Mortgage insurance comes in a few different forms, such as private mortgage insurance (PMI) and mortgage insurance premiums (MIP). PMI is typically found on conventional mortgage loans, and can be removed once you have at least 20% equity in your home. MIP is typically found on government loans such as Federal Housing Administration (FHA) mortgages. If you currently have an FHA mortgage, you’ll need to refinance to a different type of loan to get rid of your mortgage insurance premium payments.
Moves from an adjustable-rate (ARM) to a fixed-rate mortgage
Moving from an ARM to a fixed-rate mortgage can give you more peace of mind knowing that your interest rate is unlikely to increase for the life of your loan. This can be especially true if you currently have an ARM where the rate is set to adjust soon.
Access your home equity to get funding for home repairs
A cash-out refinance allows you to access your home equity and turn it into cash. You can then use that funding to pay for things like home repairs and upgrades that may increase your home’s value and make it easier to sell.
What are the downsides of refinancing?
While refinancing can have many benefits, you’ll also need to consider the downsides and costs associated with this process. Going through a refinance if you plan on selling your house may only make sense if the benefits outweigh the costs.
You’ll have to pay closing costs
Closing costs can range from $2,000 to $5,000 and up depending on the details of your loan. This includes loans advertised as a no-closing cost refinance, as rates tend to be higher to account for expenses incurred by the lender.
Some examples of closing costs can include application fees, origination fees, appraisal charges, government recording fees, title insurance, and more.
If you plan on buying another house after refinancing, these closing costs can affect what you have available for a down payment.
It takes time to get a refinance
If you’re wondering how long it takes to get a mortgage, getting approved and funded on a refinance can take between 30 and 60 days. This depends on the complexity of your loan, your lender, and the type of loan you are applying for. If you want to refinance before selling your home, be aware that it can add 1 to 2 months to your timeline.
It can lower your credit score
Getting a refinance can hurt your credit score. Applying for credit results in a credit inquiry appears on your credit. This can result in a new loan being added to your credit report. Both are items that are considered in your credit score.
Credit inquiries are tied to applications for recent credit. The more you apply for credit, the more your credit score will be negatively impacted. Similarly, the appearance of a new mortgage from a refinance will reduce the average age of your credit accounts, which also tends to lower your credit score.
The significance of this is that it can not only affect your chances of getting approved for another loan, but it can also impact whether you qualify for a lender’s lowest advertised rates.
Do you qualify for a refinance?
If you’re looking to refinance your home, you’ll need to meet the qualification requirements set forth by the lender. These can vary depending on the lender you choose as well as the type of loan you apply for. However, common qualification criteria include a review of your debt-to-income ratio and an evaluation of your home’s value and condition.
Debt-to-income ratio (DTI)
As a general rule of thumb, you should have a DTI of 45% or less to ensure you can afford a refinance. This is calculated as the amount of your monthly payments, divided by your gross monthly income.
Monthly payments that are included with your DTI calculation are your housing-related costs such as your mortgage payment, property taxes, homeowner’s association dues, property insurance, flood insurance, and any mortgage insurance premiums. It also includes any payments appearing on your credit report, such as car loans, personal loans, student loan payments, and credit cards. Federal debts such as payments to the IRS and child support payments are also considered.
Expenses that are not typically included include things like utilities, cell phone bills, internet expenses, or streaming services.
Loan-to-value ratio (LTV)
Having an LTV of 80% or less will give you a good chance of getting approved, although some programs allow up to a 100% LTV. Your LTV ratio is calculated as the loan balance of all mortgages on the property divided by the home’s value.
For a refinance, your home’s value is determined by an appraisal inspection that your lender orders. You can prepare for an appraisal by cleaning up the house and completing any repairs or renovations in progress.
Credit evaluation
Your credit score is an important factor in determining whether a mortgage lender can issue an approval for your refinance request. For most loans, you’ll need to have a credit score of 620 or higher, although some government loans such as FHA and VA loans may go as low as 500.
In addition to your credit score, your lender will also evaluate specific aspects of your credit report. This can include things like your history of bankruptcies, collections, charged-off accounts, late payments, and other derogatory items. Depending on the details of your credit report, it’s possible that you may be denied even with a sufficiently high enough credit score.
Alternatives to a refinance
A refinance can lower your monthly mortgage payment and give you access to funds to be used for things like home repairs or debt consolidation. However, it may not be the best option for everyone. If you don’t qualify for a refinance, need a faster source of funding, or are looking for a less expensive type of financing, here are some alternatives you can consider:
Home equity loan/home equity line of credit (HELOAN/HELOC)
Home equity loans and home equity lines of credit tend to have more flexible qualification requirements than that of a refinance. This is because most banks and credit unions retain servicing of these loans in their own portfolio. They are rarely if ever, sold on the secondary market, and therefore are exempt from many third-party requirements.
Personal loan
A personal loan can be a good way to get smaller amounts of funding at a lower upfront cost. While refinances typically have loan amounts that range between $100,000 and $500,000 and up, personal loans are often under $50,000 with expenses that are a fraction of what you would otherwise pay with a refinance. Qualification requirements also tend to be easier to meet, and funding speeds are also much faster.
Credit card
Common credit card limits range from $5,000 to $25,000, so this is a good option if you don’t need that much funding. Before you choose this, however, check to see what the interest rate is. Rates can be high, so this option may only be worth it if you can get a lower promotional rate, or if you intend on paying off the balance in a short period of time.
Should I refinance or sell my house?
Refinancing usually won’t affect your ability to sell your house unless the new mortgage prohibits an early payoff or has an owner occupancy clause requiring you to live in the house for a certain period of time. If you don’t have at least 10% equity in the home, you’ll also want to see how much cash you may need to cover expenses involved with the sale of the property. Otherwise, the decision to refinance should be determined by what you’ll be gaining versus the costs you’ll be paying to complete the refinance process.
