Before You Refinance: Three Hard Questions to Ask

Refinancing your mortgage can be a lifesaver, especially if you have an adjustable-rate mortgage that's rising. But before you rush to refinance, answer a few important questions about your situation. The following Q&A might help you avoid difficulty down the road.

The primary goal of a mortgage refinance is to replace a burdensome loan with one that's better suited to your particular situation. But if you enter into a refinance with too little information, it's possible to go from the frying pan into the fire. Sometimes it takes a few years to break even on the cost of refinancing, for example, so it doesn't make sense to pay for a "refi" if you're about to sell your house. Similarly, if you plan to stay in your house for decades, it wouldn't be wise to pay off a low fixed-rate mortgage and refinance into an adjustable-rate loans that's on the rise.

Most consumers understand those fundamental issues with refinancing, but they're worth reiterating because sometimes, when we're under financial stress, we don't always think clearly. Even experienced homeowners sometimes make other mistakes when refinancing a mortgage, so it's a good idea to first ask yourself the following questions, to ensure that your refinancing plan is a savvy one.

1. Can I qualify for a refinanced mortgage?

Most lenders will require that you have an accumulated equity of about 10 percent in your home before you refinance. You'll also need to have decent credit, verifiable income, and a good payment history. Without these, you may still qualify for a loan, but it will be much harder to find a lender and the rates you pay will be higher.

2. Why do you want to refinance, and how much money you will save?

Calculate both the expense of refinancing and what your new monthly payment will be. If, for example, your new payment will be $100 less than your old payment, you'll save $100 a month. If the refinance costs $1,200, you won't recoup your costs for a full year. After 12 months, you'll start saving about $1,200 a year.

3. Can you afford the cost of refinancing?

You'll have out-of-pocket expenses, and your lender should give you a written estimate of these costs. If you don't have the cash, you may be able to borrow the closing costs along with the new mortgage, and have them figured into your new monthly payment.

Before refinancing, shop around for the most competitive rates and terms. Ask your loan officer or mortgage broker to crunch the numbers for you to determine the bottom line outcome. If your lender can't answer your questions, find one who can. As a consumer, you deserve full disclosure. As a prudent homeowner, never sign up for a loan that you can't manage.