If you’re dreaming up a major renovation or hoping to capture a lower interest rate, it might seem like a good idea to refinance your home. All you need is a local lender you can trust, and you can jump right in, right?
Not so fast. Like many parts of homeownership, the refinancing process isn’t simple. Before you get too excited about a lower monthly mortgage payment for your home in San Francisco, CA or a glossy new kitchen at your home in Washington, DC, it’s important to take these few steps to prepare for a refinance and get your finances in order before meeting with a lender.
1. Run the numbers
Refinancing may seem like a good idea, but it’s important to get a complete look at your finances before you decide if a refinance is right for you. An online refinance calculator can help, but there are other factors to consider. Think about the loan term in relation to your age and your future retirement date. You may not want to reset the clock on a new 30-year loan if you’re less than 30 years from retirement. Instead, you might consider a 15-year mortgage, keeping in mind that your monthly payment will be higher.
2. Examine your credit
Under federal law, you’re entitled to a peek at your credit report once a year for free. There are three major credit bureaus: Experian, Equifax, and TransUnion. Pulling your report once a year from each agency will give you a good idea of the strengths and weaknesses of your credit. But you won’t get to see your credit score, the little number that determines so much about how much you’ll be able to borrow and what kind of interest rate you can get. If you’re not sure how good your credit is, start with the free credit report. Work on eliminating errors — they can have a big impact on your borrowing potential — and addressing any other problems. Then you might want to request your actual credit score, which will cost a little money but might be worth knowing before you attempt to refinance.
3. Get your financial house in order
Lenders like to see that you’re far from maxing out your available credit. If you carry balances on credit cards and you’re getting close to your credit limits, work on paying down your cards to create breathing room.
It also helps to show that you have enough liquid savings to pay the mortgage for several months in the event of a job loss, so building up your savings accounts is a good idea. If you don’t have the extra cash to build up savings accounts or pay down debt, a refinance could still be an option for you. Discussing your situation with some lenders will help you determine whether it’s a smart time to get started.
4. Guestimate your home’s value
Most lenders want to see that you owe no more than 80% of your home’s value. Your lender will order an appraisal as part of the refinance process, but it could be helpful to research your home’s value so you’ll know where you stand. Look up recent sales in your area, which will give you a rough estimate of your home’s value. Then compare the estimated value of your home with what you owe or what you’re hoping to borrow during the refinance process. If you owe more than 80% of the home’s value, it might not be the right moment to refinance.
5. Research lenders
Unless you have a problem with your current lender, they’re a great place to start when it’s time to refinance. Your lender wants to keep your business, so they’re likely to match the lowest available rates. But do your homework — just as with any other mortgage or large purchase, compare rates from several lenders to make sure you get the best deal.
