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Refi Readiness: How to Determine if Refinancing is a Viable Option

With the recent lowering of the federal funds rate, and the Fed's move to slash it yet again to a range of 0 to 0.25 percent, many homebuyers are scrambling to refinance their mortgages in an effort to take advantage of falling rates. However, before doing so, there are some considerations to make as to how viable an option refinancing is for you.

Most importantly, the rate advertised by a financial institution is not the rate being offered to every client. The very best deals are only going to be available for those with a pristine credit score. After all, banks need to carefully safeguard their investments. Those with a credit history dogged by late payments, defaulted loans, and loans that end in collections are going to pay more than the average, if indeed they qualify at all. It may be necessary to review your credit history as reported by the three agencies (TransUnion, Equifax and Experian) if you have not done so recently and take the appropriate steps to fix the negative items and verify that credit information has been accurately reported.

Another important factor a consumer should examine when considering a refinance is how long he or she expects to be in the home. Such knowledge plays an essential role in selecting the right financial product. A reputable lender can provide necessary guidance in helping make such decisions. Other aspects to consider are how much lower the interest rate will be on a new loan, closing costs, equity built up in the home, and whether the purpose of the refinancing is to generate cash.

Also, bear in mind how long it will take to recoup the closing costs. To do so, divide the upfront cost (all closing costs) by the monthly savings you expect. This will indicate how many months it will take to break even. If it's going to take five years to break even, and you expect to stay in the house for only four years, it's likely not worth it. Also, if acquiring that attractive lower rate is going to require paying points, think carefully how beneficial this will be in the long run. Some consumers want the very best rate their money can buy. For others paying a lump sum to achieve that rate may prove to be detrimental.

It may seem logical to refinance with the current lender because the lender knows the payment history and property. However, this may be a bit trickier than it seems. For instance, the firm that originated the existing loan may not have retained it, which means you are not considered a current customer. And the current lender servicing the loan may not be handle originations in your market, which means they are unable to service a new loan.

It's a good idea to shop around for the best rate and terms, such as closing costs. For those who will apply for a loan through several lenders, do so in a 30-day period. Your credit score won't be hurt by comparison shopping if the applications are made within a short time frame.

When looking at the bottom-line numbers, don't forget to take into account not only the principal and interest, but items such as property taxes, private mortgage insurance, and homeowner insurance. Together, these add up to the monthly payment which should represent approximately 25 percent of your monthly take-home pay for the average American.

While it won't have an impact on the outcome of the application process, when considering a refinance, think about how the additional income will be used. Many choose to invest the difference to build up their financial portfolio. Others may use the cash to make home improvements, bill repayment, or education costs for children. Whatever the reason may be, determine in what way the additional cash will be applied.

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