5 reasons to think ahead about refinancing

Posted by  on Jul 12, 2014

You can't control mortgage rates.

That simple fact can give refinancing something of a lottery feel -- some mortgage borrowers are lucky enough to get the opportunity to refinance, while others are stuck with the same rate for the entire life of their mortgages.

Still, while there is an element of luck in the movement of refinance rates, there is also some degree of planning that determines who can refinance. This is because the movement of refinance rates is just one factor that determines whether you will get a chance to refinance. There are a number of other things that have to line up as well.

Making sure everything lines up when the time comes requires thinking ahead -- beginning from when you choose your initial mortgage. Here are some of the ways thinking ahead can help you be ready to refinance if rates give you the opportunity:

  1. Make a significant down payment. To get the most competitive mortgage terms these days, you are likely to need a 20 percent down payment. If that seems like a burden, keep in mind that a large down payment also puts you in a better position to refinance later on. A bigger down payment gives you a healthy equity cushion, leaving you less chance of finding your loan under water due to price fluctuations.
  2. Watch out for prepayment penalties. When choosing your initial mortgage, pay attention to any penalties for early repayment of the loan. These penalties often diminish over time, but a steep enough penalty could preclude you from refinancing in the early years of the loan. Remember, the opportunity might not come up more than once; and in any case, the sooner you refinance the more you can save, so even a penalty that applies over the first few years could turn out to be an important obstacle.
  3. Keep your credit in shape. Just because you have your mortgage does not mean you can become careless about your credit usage. If you want to refinance, chances are you will have to qualify all over again, especially if you want access to the best mortgage rates.
  4. Keep your home in shape. Just as with a purchase mortgage, refinance lenders are going to want an equity cushion between the value of your home and the amount you are borrowing. So it is important not to allow the value of your home to deteriorate because of damage or poor maintenance.
  5. Focus on the right target. When you track rates to see if refinancing makes sense, be sure you are looking at the right types of mortgage. If you started with a 30-year loan, you should probably focus on 30-year refinance rates initially, but after several years of principal payments refinancing to a 15-year loan might be a better fit. In the last 10 years of the loan, a short-term adjustable-rate loan might even make sense.

The irony about refinancing is that the best situation is never to have refinance rates go low enough for refinancing to make sense -- that would mean you had been getting the lowest mortgage rate possible all along. Thinking ahead can help in this respect too, by buying when rates are low and comparing mortgage rates to get the best deal right from the start.

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