3 Things You Must Do Before You Apply for a Mortgage Refinance

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Thinking of getting a new home loan? Check these items off your list first.

There are plenty of good reasons to swap your existing home loan for a new one via a mortgage refinance. For one thing, today's refinance rates are so competitive that you could lower your monthly payments substantially by getting a new mortgage. Also, refinancing will allow you to alter the terms of your mortgage -- such as the length of your repayment period -- so that your loan works better for you.

But before you rush to refinance, you'll need to take a few key steps. Here are three items to check off your list.

1. Make sure you're planning to stay in your home for a while

Refinancing can make a lot of financial sense -- but only if you'll be in your home long enough to reap the benefit. When you refinance a mortgage, you're charged closing costs to finalize that new loan. Those fees typically amount to 2% to 5% of the loan you're taking out, and you'll need to make sure you'll stay in your home long enough to break even from those costs and come out ahead financially.

Say you're looking to refinance a $200,000 mortgage and you'll be charged 3% closing costs to do so. That means you'll pay $6,000 up front.

Now, if refinancing lowers your monthly mortgage payments by $300, you'll break even in 20 months, so if you're not planning to move for at least four or five years, then refinancing makes sense. But if you think you might move in a year and half, then you could actually lose money by refinancing.

2. Check your credit report and score

To qualify for a competitive refinance rate, you'll need good credit. And it's a smart idea to check your credit score before applying for a new home loan. That way, if it's not in great shape, you can work on boosting it before applying.

Along these lines, it's a good idea to check your credit report for red flags, even if your credit score seems to be in decent shape. It could be that your credit report contains a mistake that's dragging your credit score down by, say, 40 or 50 points. Correcting that error could bring your score up and allow you to snag an even more attractive mortgage refinance rate.

For example, say you have a credit score of 730. That's a good score, and one that should land you a pretty low refinance rate. But if you can get your score up to a 780, you might get a rate that's even lower.

3. Decide whether you want to take cash out of your home

Many people who refinance swap their existing loan balance for the same sum of money. But you may want to consider doing a cash-out refinance, where you borrow more than your remaining loan balance.

Say you owe $200,000 on your mortgage but your home is now worth $270,000. Let's also say you owe $15,000 in credit card debt that's costing you a lot of money in interest. If you were to do a cash-out refinance for $215,000, you'd have the option to pay off that credit card balance, and then repay your new mortgage at what's apt to be a much lower interest rate.

Some people also do cash-out refinances to cover the cost of home improvements or necessary repairs. If your home is worth a lot more money than your remaining mortgage balance, think about whether taking some cash out of your mortgage makes sense.

Based on where refinance rates are sitting, now's a very good time to apply for a new home loan. Make these moves first, though, so you benefit as much as possible from refinancing.

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