3 Things to Do Before Refinancing Your Mortgage in 2021

by Maurie Backman | Updated July 19, 2021 - First published on Feb. 7, 2021

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Don't apply to refinance until you check these items off your list.

Refinancing a mortgage is a great way to lower your monthly payments and reap serious savings. And given the way today's refinance rates are trending, many borrowers are finding that now's a great time to get a new home loan. But before you rush to jump on that bandwagon, make sure to tackle these key items.

1. Do an interest rate comparison

Today's refinance rates may be low, but what if you're already paying a low interest rate on your mortgage? In that case, refinancing may not make sense due to the fees involved.

Generally, refinancing is a good idea when you can shave about a full percentage point off of your mortgage. This means that if you're paying 3.85% interest today, you'd ideally want to refinance to a loan at 2.85% interest. Of course, that 1% savings target isn't exact -- there's a little wiggle room. But if you're paying 3.25% interest, it generally doesn't make sense to refinance to a 2.85% interest rate.

2. Figure out how long you plan to stay in your home

The average U.S. homeowner paid $5,749 in closing costs in 2019. Closing costs are unavoidable when you refinance a mortgage, and though they're not set in stone -- each lender establishes its own fees -- they can eat into your savings. In fact, you won't really save any money on your housing payments until you break even from your closing costs. So if you're not planning to stay in your home very long, refinancing could end up not making sense.

Say your lender wants to charge you $6,000 in closing costs to refinance, but in doing so, you'll lower your monthly mortgage payment by $250. That means it will take 24 months for you to break even and start enjoying some monthly savings. If you plan to stay in your home another three or four years, that refinance is worthwhile. But if you think you might move within two years, then you shouldn't refinance because you could end up losing money in the process.

3. Make sure you're a solid borrowing candidate

Having an existing mortgage doesn't mean you'll automatically qualify to refinance. In fact, if your credit score is poor and you've racked up a lot of debt since initially signing your mortgage, you may not get approved to refinance at all.

Before you apply, see what your credit score looks like. Keep in mind that if you want a competitive refinance rate, you'll generally need your score to be in the mid-700s or higher. You'll also need to make sure your debt-to-income ratio isn't too high and that you have a steady job to make lenders comfortable with the idea of giving you a mortgage. See where your finances stand before applying for a new home loan because you may have some work to do before taking that step like boosting your credit score.

There are plenty of good reasons to refinance a mortgage today, but don't assume that doing so makes sense for you. It could be that it pays to wait on refinancing until your circumstances change or rates drop further (which may or may not happen). The key is to assess your own situation and needs before rushing to swap your existing home loan for a new one.

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