Refinance Your Mortgage
To refinance or not to refinance is not the question here. Thanks to the ongoing pandemic, the Federal Reserve has kept the interest rates fairly low. But is now a good time to refinance? Unfortunately, the answer is not that simple.
Refinancing your mortgage refers to the process of taking out a new loan to replace the present mortgage. The mortgage is one of the substantial financial burdens. So, it makes sense to seize any opportunity to reduce the burden a little. That means you could refinance your mortgage and save.
With many homeowners seeking to make better use of the interest rates and refinance, it may soon be late. For example, the average interest rate on a 30-year fixed-rate mortgage was below 3% in April 2021. But by May, it has increased to 3.28% and will continue to increase. However, this increase was predicted by many groups, including Fannie Mae and The Mortgage Bankers Association.
Here is everything you need to know about refinancing:
When Is a Good Time to Refinance Your Mortgage?
Generally speaking, mortgage refinance is a good idea to lower the interest rate by at least .5% – 1%. This will substantially lower your monthly payment.
Moreover, the new loan will be based on the balance of the original mortgage. So, if you had paid some of your principal, refinancing could lower your monthly payments and save money.
In addition to that, how long do you want to stay in your home? What are your financial goals? What is your home equity and your current credit score? These factors also play an essential part in refinancing. So, if everything works out, now is a good time as any to refinance your mortgage.
Is Refinancing Worth It?
Refinancing is worth it if you use it for the right reasons. If not, it can quickly increase your financial burden. While lower interest rates may be attractive for one person, others may prefer to refinance for higher monthly payments.
While .5% – 1% makes sense, even a modest 25% makes sense if the costs are low. So instead of looking at the new interest rate, look at the broad picture. Consider how much you will save per month, how much you will save over the loan term and the closing costs.
How Does Refinancing Your Mortgage Loan Work?
The refinancing process is similar to the mortgage loan. You can replace the current loan with a new loan, often with a lower interest rate. After you refinance your existing mortgage, you will have a much favorable interest rate. Monthly payments will be lowered, and possibly a different lender than your original loan.
However, with the new mortgage, you would be resetting the clock depending on the terms. For example, consider you are five years deep in your 30-year mortgage with 25 years on the clock. If you refinance for 30 years, you would be extending the loan terms. However, if the term is 20 years, you would be able to pay off the loan sooner by five years.
Keep in mind that you’d have to pay closing costs which can be a few hundred dollars. Alternatively, they can be anywhere between 2% to 5% of the loan amount. In addition, it may include an origination fee, appraisal fee, and discount points.
According to Ellie Mae’s Origination Insight Report, the average time to refinance a conventional mortgage is about 38 to 48 days in 2019-2020. However, it can take more than a week longer than a conventional loan for FHA and VA loans.
Why Should You Refinance Your Mortgage?
Refinancing doesn’t come free. So, if you are looking to refinance your most significant debt, you better have a good reason. As such, you need to have a clear head about your refinancing goals.
Here are some of the reasons why someone would refinance a mortgage.
Save Money on Lower Monthly Payments
Even the slight difference in the interest rate can create a noticeable impact on your monthly mortgage payments. For example, consider a 30-year $300,000 loan with a fixed interest rate of 4% and a payment of $1,567. Refinancing the loan to the same period with a 3.25% interest rate, your monthly payment drops by $134. This amounts up to $48,420 over the life of the loan.
With a lower interest rate, your new monthly payment will most likely shrink. In addition, it allows you to save money. You can put up the monthly savings against your principle. Or use it for other expenses like an auto loan or maybe your retirement fund.
However, it makes sense to pay off the home loan instead of refinancing for lower payments. At the same time, you may have to sacrifice your savings, including your retirement savings, to finish your loan first. But the advantage is that you will have a home with no mortgage payments. Now you can get back to savings and investments.
Save on Interest Costs
A low-interest rate decreases the mortgage interest you pay throughout the loan.
Both the interest rate and loan term decide how much you save in interest costs over the life of the loan. Reducing one or both factors can result in increased savings both in mortgage interest rates and monthly payments. However, you can prepay the interest in paying for mortgage points.
Ensure that you shop around with multiple lenders for better mortgage rates and terms. Before seeking a new lender, ensure that you check with the current one. They may even offer a better rate if you stick with them.
Get Shorter Loan Term
In 2019, Freddie Mac reported that 78% of borrowers refinanced from a 30-year fixed-rate mortgage to a similar loan. In addition, 14% went from a 30-year fixed to 15-year. And a last 7% refinanced from a 30-year fixed to a 20-year fixed.
Freddie Mac also reports that people refinancing their 30-year mortgages to 15-years pay less interest over a long period of time. They also shave years off your loan. On the downside, your monthly mortgage payment will increase. However, this can help save the interest payments if the property doesn’t qualify for an interest deduction.
Tap into Home Equity
With refinancing your mortgage, you can convert the equity into money and borrow it on your current loan. In such a case, the lender gives you the difference as check or cash which is called a cash-out refinance. However, the condition is that, to qualify for the loan, you need to have enough equity, at least 20% or more.
A survey by Black Knight indicates that 45 million homeowners have tappable equity lying unused. With a cash-out refinance, you can convert the equity to usable money, which you can use for investments or home improvements.
Refinancing offers a low interest rate compared to other mortgages. Hence, it is attractive for homeowners looking to pay off debts. Since the loan allows you to tap into the equity, you can take advantage of the cash-out refinance option. You can use to consolidate debts like personal loan, credit card debt, student loans, or home loan into one single loan. Your loan balance depends on the equity you decide to cash in.
Keep in mind that if your home equity falls below 20%, you may have to pay mortgage insurance on an FHA loan.
Remove Private Mortgage Insurance (PMI)
PMI comes into the picture when you do not have enough down payment for a mortgage. It can cost you a considerable sum every month until the home equity builds to 22%. At this juncture, your lender is required to cancel it if the monthly payments are current.
However, you can get rid of mortgage insurance early by refinancing your loan. But they are an expensive option with closing costs as high as 2%-5% of the loan amount. But if you have other benefits such as a low-interest rate and short break-even point, you can opt for refinancing.
If you are stuck with an FHA loan, and you may be paying PMI for 11 months or even the life of the loan. This depends on how big your down payment was. In such a case, refinancing may be the only option.
Ability to Switch Mortgage Types
Some borrowers refinance their mortgage to convert their adjustable-rate mortgage (ARM) and lock in on a fixed-rate loan. This is true if the current mortgage rates are low and not planning to sell shortly.
In the same line, it makes sense to move from an ARM to a fixed-rate loan in certain situations. For example, this works if you plan to sell in a few years and are not afraid to take on a higher interest rate. It eliminates the fear of future interest rate hikes.
Is Refinancing a Bad Idea?
No rule says refinancing your mortgage is a bad idea. On the contrary, if done right, refinancing your loan can help save a few hundred dollars at least. However, certain factors can drive up the expenses and cost you more in the long run, so caution is advised.
Longer Loan Term – To calculate the profitability of the refinancing loan, take the mortgage rates as well as loan term for a complete picture. Do not take refinance if you aren’t saving enough.
Higher Closing Costs – The closing costs come with unnecessary fees such as loan processing and application fees. Moreover, if you cannot pay the upfront costs and instead add them to your mortgage, you’ll end up paying more.
Moving Soon – If you see yourself moving soon, it is a bad idea to refinance your current mortgage. This is because you are not likely to save enough to outweigh the loan’s closing costs.
Is it Worth Refinancing a 30-Year Mortgage into a 15-Year Mortgage?
At the beginning of a 30-year loan, most of the monthly payments go towards the interest costs. Unless you pay into the principal, you would not be able to build home equity for many years to come. Or you can refinance it into a 15-year loan. While this helps to build the equity, you’ll be taking on a higher monthly payment. If you are someone looking for a lower monthly payment, it may not be ideal for you.
With a 15-year mortgage, you are looking at:
- Low-interest rate
- Low-interest costs
- Pay off the mortgage quicker
- Higher monthly payment
- No flexibility
- No leeway in case your financial situation worsens
- Less investment and savings
However, you can refinance the current loan to a longer term and tide it over if the situation warrants it. When personal finances change for the better, you can save up and pay the principal faster.
Am I Eligible for a Mortgage Refinance?
To refinance your mortgage, you’d have to go through a refinancing process, starting with the application. FHA and VA loans qualify easier than conventional loans.
The qualifying criteria for a mortgage refinance are similar to a new mortgage. The most important of them are:
Credit Score: Most mortgage lenders require a credit score of 620 to be eligible for mortgage refinance. However, for a competitive interest rate, you need at least 740.
Debt-to-Income (DTI) Ratio: The lower the DTI ratio, the better your interest rate. However, it depends on the lender as well. Few go as high as 43% for conventional loans, while 50% for FHA loans.
DTI Ratio = Total Monthly Debts ÷ Total Monthly Income
Apart from these, mortgage lenders create their eligibility criteria. As such, there are a few other factors that lenders consider:
- Credit history
- Employment history
- Payment history on the current loan
- Home equity
- Home’s current value
Once you meet the lender’s criteria, you’ll receive an offer with the interest rate depending on the risk you pose. However, you may not get approved or receive favorable terms if your credit history has taken a wrong turn since the first mortgage.
What to Consider Before Refinancing
Before you refinance the loan, consider why you want to refinance your mortgage. To start with, how long do you intend to stay in your home? If you are planning to move in the next few years, stop right there. Refinancing is not the right option for you.
Current Interest Rates: The success of refinancing lies in the interest rate. Even the slightest change in the rate can create a huge impact. Hence, experts recommend you interview several lenders, including your current lender, to find one suited for your current financial situation.
Mortgage Term: Refinancing to a lower interest rate can help you save money but not increase the mortgage terms. That can be counterintuitive since you end up paying more interest over the life of the loan.
Cost of Refinancing: Ensure that you stay in your home at least until you recoup the cost of the refinancing. Refinancing comes with closing costs, including the exact fees and services as when you purchased your home. So, if there is a chance that you may move before you recoup the costs, refinancing is not one of the best financial decisions.
Find the Best Refinance Rates
Just like your initial mortgage, you need to take some time and shop around for better interest rates for the new loan. Look for independent vendors, credit unions, banks, and online comparison sites. If not, you can approach a mortgage broker who can open venues that were previously hidden. They can do the legwork and get you access to vendors and better loan terms.
Make a list of preferred vendors and submit 3-5 requesting loan estimates. It has the estimated interest rate, closing costs, annual percentage rate, and monthly payment. When it comes to mortgages, you’d be better off with a loan that has a high APR, high monthly payment but no fees. Experts suggest you do not pay closing costs with cash; instead, lock it in with the loan amount. And invest the money or stash it for an emergency fund.
Refinancing is a shaky subject, to say the least. While it has its benefits, it is not without drawbacks as well. Refinance loans work well only if you focus on the long-term goals and not on the short term. Having said that, you should go for it, as refinancing could get you through a financial rough patch. A higher credit score, lower debt-to-income ratio, or increased equity could all help you qualify for a better interest rate.
So, is now a good time to refinance? As a rule, the best time to refinance depends on your financial situation. With the interest rates at record lows refinancing can lower your monthly mortgage payments and increase your monthly savings.
Priority Lending, LLC has been providing mortgage loans and helping people like you fulfill their dreams since 1997. Contact one of our loan officers today to get started on refinancing your mortgage.