Refinance rates, Mortgage rates have plunged to all-time lows, yet many American homeowners are passing up a prime opportunity to lower their interest rates and cut their monthly payments by refinancing their loans.
While the savviest homeowners refinanced, and some have even done so twice, millions more have yet to take advantage of rates that once would have seemed unthinkably low.
Finding the Best Refinance Rate
Getting a great deal on a home mortgage refinances depends largely on the refinance rate you get. The conventional wisdom goes that it’s not worth refinancing if you can’t get a rate that’s at least 1% lower than your current mortgage rate. And it’s not just because refinancing involves hassle and paperwork. Refinancing a mortgage costs money, too, so you want to make sure that you at least break even on the transaction.
The term “refinance” can be a bit misleading. When you refinance, you’re getting a brand new mortgage. The new mortgage pays off your old mortgage, and you have to pay back your refinance mortgage promptly. But to refinance, you’ll have to go through a lot of what you went through to get your original mortgage. That means applying for the mortgage (and having the credit score to qualify for a low rate), dealing with paperwork, and paying closing costs and other fees. You don’t have to use the same mortgage lender you used for your first mortgage but even if you do, you’ll still have to pay closing costs.
Also Read: 8 Things You Need To Know About VA Loan
Why should you refinance?
So why should you bother to refinance if it’s such an investment of money and effort? In many cases, it’s to pay a lower interest rate on your home loan. If you initially get a mortgage with a rate of 5% and learn you can refinance to a mortgage with a rate of 4%, you might decide it’s worth the cost and trouble of refinancing to nab that lower rate. But getting a lower refinance mortgage rate is not the end goal in itself. The end goal is usually lower monthly payments. That means more room in the homeowner’s budget, less money paid to the lender, and more equity more quickly.
In other cases, you can refinance to get access to the money you have stored in home equity. As you pay back your mortgage, in payments that consist of both principal and interest, you gradually own more and more of the house. The amount of principal you’ve paid back is your equity. A cash-out refinance enables you to take some or all of that equity out and use it for say, home improvement, credit card debt repayment, or to cover an emergency.
Also Read: 10 Best Excel Tips For You
When you refinance, whether you take out cash or not, you re-start the equity clock. Your early payments on your refinance mortgage will go primarily to interest, just like they did when you first started your home purchase mortgage. And if you refinance from one 30-year mortgage to another, you’ll be paying a mortgage on your home for over 30 years. If you want to be free of your mortgage sooner you can always refinance to a 15-year mortgage, but few people do this because it involves higher monthly payments.
Risk in Refinancing
Say you pay the closing costs, the inspection fees, appraisal fees, title fees, attorney fees, and more, all to refinance your home. By the end of the process, you’ve spent thousands of dollars. Now say you get a job in another city and decide to move, walking away from the mortgage you’ve just refinanced. You’ll never recoup what you spent to refinance your mortgage. That example illustrates what’s probably the biggest risk involved in refinancing.
That’s why experts generally agree that refinancing to a mortgage with an interest rate that’s only a fraction of a percentage below your current rate generally doesn’t pay. But basing your refinance decision on the interest rate alone (as per the 1% rule we mentioned above) is over-simplifying things.
Should You Refinance?
If refinancing is so great, why doesn’t everyone do that? It’s a question that has puzzled economists and housing policy analysts. It’s estimated that millions of Americans missed out on the chance to save money by refinancing their mortgages after the housing crisis. Some of those millions of homeowners may not have realized that refinancing was an option, or may not have qualified for a refinance because of their credit scores or income. But even among homeowners with excellent credit there were missed opportunities to refinance.
Refinancing a mortgage is exactly the kind of task that most of us like to put off, or avoid altogether. It takes sustained attention to detail, plenty of paperwork, and wrangling with a bureaucracy.
That’s all to say that if you take advantage of the savings offered by refinancing, you’re ahead of the personal-finance curve. But it’s only worth doing if you’ll save money in the process. That means being realistic about how long you plan to stay in your home, getting your credit score in order, finding the best refinance rates, and saving money where you can, such as on inspection fees and closing costs. Before you decide to take the plunge, take a look at current refinance rates and compare them to the rate you’re currently paying.
Things to know before you Refinance
Refinancing your home mortgage could potentially reduce your interest rate and monthly payments or give you access to some of the equity in your home. But that doesn’t necessarily mean it’ll save you money or it’s a good decision.
If you’re thinking about refinancing your mortgage loan, here are 10 things to keep in mind before you pull the trigger.
Your reason for refinancing
Refinancing a home loan can be expensive, so it’s crucial to know why you want to do it. For example, maybe you want a lower interest rate or monthly payment, or you want to do a cash-out refinance to pay off high-interest debt or make some home improvements.
Whatever your reason, make sure it’s worth the costs and work associated with refinancing your existing mortgage.
The current mortgage rates
It generally doesn’t make sense to refinance your home loan unless they’re lower than what you’re currently paying. Before you start submitting applications, check the current mortgage rates to see how they compare with your existing mortgage.
Also, keep in mind that just because mortgage rates are lower now, that doesn’t mean they’ll stay that way. If reducing your interest rate and monthly payment are your top priorities, start applying sooner rather than later.
The type of rates advertised
As you compare your current loan with market rates, make sure you’re comparing apples to apples. For example, adjustable-rate mortgages typically start with lower interest rates than fixed-rate mortgages. However, after their initial fixed period, they can fluctuate based on the current market rates.
Also Read: 10 Best Franchises You Can Buy From
So if you have a loan with a fixed rate, make sure you’re comparing it with new fixed-rate loans, unless switching to an adjustable rate is your goal. In general, though, it’s more common to switch from an adjustable rate to a fixed rate for more certainty.
Your credit score
While average mortgage rates can give you an idea of whether or not you can save, your actual rate on a refinance loan will depend largely on your credit history, existing debt, and income.
Check your credit score to see where you stand. If it’s lower than it was when you first bought the home, you may need to take steps to improve your score before you apply. Credible online tools can help you compare lenders without any impact on your credit score.
Your debt-to-income ratio
Your debt-to-income ratio—how much of your monthly gross income goes toward debt payments—is a major factor in determining your eligibility for a mortgage loan. If you’ve taken on more debt since you obtained your existing mortgage loan, it could make it difficult to refinance.
Your home’s equity
If you’re hoping to tap some of your home equity with a cash-out refinance, the home value is an important indicator of whether you’ll qualify and how much you can take out.
In general, lenders will allow you to borrow up to 80 percent of your home value. So if the home is worth $300,000, the maximum new loan is $240,000. If your current loan is for $200,000, you could potentially get up to $40,000 in cash with a cash-out refinance. But if your loan is at $240,000 or above, you likely won’t qualify.
Closing costs on a mortgage refinance can range from 2 percent to 6 percent of the loan amount, which can run in thousands of dollars. If you don’t have enough cash to pay those closing costs out-of-pocket, you may be able to roll them into the new loan—assuming the loan still meets the requirement of being 80 percent or less of the home value.
However, rolling them into the refinance means you’ll be paying interest on them over the life of your new loan.
If you’re refinancing to save on your monthly payments, you’ll need to divide the monthly savings by the amount of the closing costs to determine how long it’ll take you to break even on those upfront expenses. If you’re planning to move before that time, it may not make sense.
Consider using an online refinance calculator to help you determine whether refinancing makes financial sense.
If you put down less than 20 percent when you first bought your home, you may be paying private mortgage insurance (PMI). With some government-backed loans, you may be paying some other form of mortgage insurance.
Depending on how much your home value has increased and how much of your current loan you’ve paid down, though, refinancing could help you eliminate mortgage insurance from your monthly payments, increasing your savings.
Your new mortgage term
Refinancing not only allows you to get a new interest rate but also a new repayment term. You can generally choose between a 10-year, 15-year, or 30-year mortgage. While a shorter term will ensure you’ll be debt-free sooner, you’ll want to make sure you have enough room in your budget for a higher monthly payment.
And while resetting to a 30-year mortgage again can reduce your monthly payment, it will also result in more interest over the life of the new loan.
The bottom line
Refinancing your mortgage isn’t always a good idea. Take your time to understand your situation, research your options and run the numbers to make sure it’s the right time and the best path forward.