Homeowners are buzzing about it...
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Is Now A Good Time To Refinance Your Mortgage Loan?
By Shelley Murasko
If you have been looking for a way to access extra cash or to save thousands in interest, refinancing your home may be a sound strategy. With interest rates plunging to their lowest point in 50 years, homeowners with good credit are snagging average interest rates of 2.98% for 30-year fixed rate mortgages.1
By securing one of these ultra-low interest rates, you could be saving tens of thousands of dollars over the life of your home loan. And that’s money you could put toward investments that will further grow your nest egg.
If you haven’t refinanced yet, here are a few reasons why you should be considering it.
Why should you refinance?
When you refinance, you replace your old loan with a new one. This transaction allows you to settle your current mortgage and set up a new loan with better terms to pay off the remaining balance.
Homeowners refinance their mortgages for many reasons, and your best friend’s or your neighbor’s motives may differ from yours. Here are some of the most common reasons to refinance your home:
· Lower your interest rate and monthly payments
When you lower your interest rate, you could save thousands of dollars throughout your loan’s lifetime. Depending on the length of your loan, you could reduce your monthly payments too. If your income has decreased due to the current economic downturn, lower monthly payments would leave extra cash to pay for essential items like food, utilities and gas or help you reduce debt from credit cards and car payments.
For example, let’s say you have a 30-year fixed rate loan with a remaining balance of $350,000. Your current interest rate is 4.125% and you have excellent credit. If you refinanced with a 30-year fixed rate loan at 3.125%, you’d reduce your payment by $350 per month while also saving $16,000 in interest over the life of the loan.
· Shorten the term of your loan
If you’ve been paying off your loan for a decade or more, you may want to consider swapping your 30-year loan for one with a shorter-term such as a 10-year, 15-year, or 20-year. While this may drive up your monthly payments, you’ll increase your equity at a faster rate and reduce interest fees, saving you money in the long-run.
Using the same example from the bullet above, you could save a significant amount of money if you swapped your 30-year loan for a 15-year fixed rate loan at 2.75%. In this case, you’d increase your monthly payment by $500 per month, save $130,000 off the interest over the life of the loan, and pay off your mortgage seven years earlier.
· Cash-out refinance
If you’ve built up equity in your home, you can cash out and use it to invest the money in other ways. For example, you could use the funds to strengthen your investment portfolio, start a business, or save for a child’s education. The cash you receive in this type of transaction is tax-free and you can spend it however you want.
· Change loan type
If you currently have an adjustable rate mortgage (ARM) and are worried about rates increasing in the future, refinancing offers the opportunity to switch to a fixed rate loan. With interest rates at an all-time low, you could lock in an excellent rate that will save you money and give you peace of mind.
· Get rid of mortgage insurance
If the down payment on your original loan was less than 20%, you’re likely carrying private mortgage insurance (PMI) on top of your monthly mortgage payment. This can exceed 1% of your loan principal. To get rid of this liability, you can refinance into a conventional loan and reduce the lifetime borrowing costs. To remove the PMI, your home must have increased in value and/or you must have built up at least 20% in equity.
· Consolidate debt
Some homeowners opt to refinance to consolidate debt and pay it off at a lower rate. While this may work in theory, you may find yourself in the same situation in the future if you don’t change your spending habits. The danger here is that you could end up losing your home if you default on your loan. Only refinance for this reason if you can commit to making your monthly payments and ideally preserve 20% equity in your home.
Whatever reason you have for refinancing, the most popular goals are to save money by reducing monthly payments and/or pay less interest over the life of the loan. Just keep in mind that there are hefty closing costs you’ll have to pay to establish the new loan, which can range from $3000-$10,000. Some of these costs include:
· Loan origination fees – can be as high as 1.5% of the loan value
· Appraisal fees – usually $500 or less
· Mortgage discount points – each point costs 1% of the loan value to get a 0.25% rate decreas
· Title insurance premiums – ranges between $400 and $1,000
· Title insurance changes, if needed – varies depending on loan size
· Upfront fees to impound mortgage insurance and property taxes, if needed – varies
As you can see, these costs can add up quickly. That’s why it’s important to clearly understand what you’ll be paying before you commit to a refinance. In addition, be sure to add in any prepayment penalty on your current loan to get the full view of your potential payout.
When should you refinance?
Under normal circumstances, experts say it’s a good time to refinance if you can lower your interest rate by at least 2%. Some even believe a 1% savings is enough incentive to proceed.2 With interest rates sinking below 3% in July and August, it’s a wise financial move to at least look into it.
But don’t wait too long. Interest rates won’t stay this low forever, and the sooner you act, the better your chances are of locking in a competitive rate.
To decide if refinancing is an option for you, start by running an analysis using these mortgage refinance calculators:
· https://financialmentor.com/calculator/mortgage-refinance-calculator
· https://www.bankrate.com/calculators/mortgages/amortization-calculator.aspx
What items do you need to refinance?
If you decide you do want to pursue a refinance, a lender is far more likely to approve you for a loan if you can show you’re a low-risk prospect. Here are a few items that will increase your chances:
· Good credit
If you have a high credit rating, you’re more likely to get approved for a loan with a low interest rate. You typically need a minimum credit rating of 620 for a conventional loan or 580 for a Federal Housing Administration (FHA) loan. If your credit rating is too low, you can increase it by fixing errors, paying down credit card balances and staying below your spending limits.
· Steady stream of income
Lenders want proof that you’ll be able to repay the loan. If you’re gainfully employed, you have an advantage because you’re more likely to get approved. If you’ve been laid off or furloughed, this will count against you. Unemployment payouts are not considered steady income, so they won’t help your case. The exception is if you are a seasonal employee who receives unemployment consistently during your off-season working periods.
· Sufficient equity
When assessing risk, lenders use the loan-to-value (LTV) ratio as an indicator. This is the loan amount you owe compared to your home’s current market value. A high LTV ratio means you’re a risky investment because the lender would lose a greater amount of money if you defaulted on the loan. A low LTV ratio means you have ample equity and owe less on the loan than your home is worth. This makes you a better candidate.
For a home mortgage, you can quality if you have at least 20% equity and an LTV ratio of up to 80%. Equity of at least 20% also removes the need for private mortgage insurance, which can eliminate fees of 1% or more over the lifetime of your loan.3
What’s the process to refinance?
If your credit, equity and source of steady income are in good shape, you’re ready to begin the refinancing process. Here’s what you’ll need to do:
· Gather income-related documents. This includes items like your most recent pay stubs, bank statements, tax returns, proof of insurance, and personal identification.
· Prequalify for a loan. Reach out to lenders for a “soft credit inquiry” that won’t harm your credit score. This can tell you what loan amount you’ll qualify for along with the interest rate and terms you can expect to get. Be sure to shop around to at least three lenders to determine which lenders provide the lowest mortgage rates.
· Apply for the refinance loan. Contact your selected lender and provide the appropriate paperwork about your income, identity and current loan parameters.
· Schedule the closing. During this phase, you’ll need to get a home appraisal, and the lender will proceed with the needed paperwork.
· Sign the closing documents. You’ll get your closing paperwork about three days before closing. At this point, you’ll need to sign multiple documents to complete the transaction.
· Get set up with your new lender. Once the loan closes, your new lender will pay your former escrow and mortgage companies. From that point on, you’ll be dealing only with your new lender to make payments.
Normally, you’d be able to close on your refinance loan in about 30 days. With the favorable interest rates, however, multitudes of homeowners have been clamoring to refinance over the past six months. This means you’ll likely find a backlog awaiting you, so expect a longer wait time.
What if you don’t qualify?
If you’ve been laid off or furloughed due to the current economic situation, you’ll find it hard to qualify for refinancing. Lenders require proof of a steady stream of income before they’ll grant you a mortgage. Fortunately, you have other options that could still get you the loan.
· Get a cosigner
If you’re unemployed or your credit score is low, you may still be able to refinance your home if you have a cosigner. This is a person with a steady income who promises to pay the loan payments if you’re unable to. If he or she has a strong credit rating, the odds of you getting the loan increase.
· Research government loan programs
If you don’t have enough home equity built up, refinancing programs through the Federal Housing Administration, U.S. Department of Agriculture and U.S. Department of Veterans Affairs may be able to help. You must meet certain criteria, but it’s worth looking into.
Federal loans backed by Fannie Mae and Freddie Mac are another option. These government lenders allow you to use unemployment benefits as income, but only if you’re a seasonal worker.
A third route is to ask your lender or mortgage servicer about coronavirus mortgage relief options. Learn more about them at these links: https://www.investopedia.com/how-to-get-mortgage-relief-4800539 or https://www.consumerfinance.gov/coronavirus/mortgage-and-housing-assistance/mortgage-relief/.
· Discuss options with your current lender
Lenders want to get repaid, so they’re often willing to negotiate a new payment plan or a loan modification. The latter is a change in your current loan terms, which can reduce your monthly payments and make them more affordable. Give your lender a call and see what they can do to help you.
· Talk to a HUD-approved housing counselor
A housing counselor can help you figure out the options available to you, based on your current situation. Many of the services offered are free or at low cost, and you can access help online or via phone. Get more details here: https://www.hud.gov/i_want_to/talk_to_a_housing_counselor.
· Prepay your mortgage by sending in extra payments on a periodic basis instead.
For many homeowners, the higher monthly cost of a shorter loan term isn’t in the budget. This is why some homeowners skip the refinance and opt to “prepay” their mortgage instead. You don’t get access to new, lower rates, but you take better control of your loan.
· Prepaying your mortgage means to send “extra” payments to your lender each month, which chips away at the amount you owe faster than your amortization schedule prescribes.
How to avoid refinancing pitfalls
Refinancing your home can be a complicated process, so be sure you understand what you’re getting into if you decide to proceed. You can avoid the traditional pitfalls if you follow the tips below.
· Factor in the closing costs. While refinancing can save you in terms of monthly payments or overall interest fees, it also comes with hefty closing costs.
· Don’t refinance if you’re planning to move soon. After your refinancing goes through, you’ll want to stay in your home long enough to recoup your closing costs. For example, let’s say you save $200 in monthly payments by refinancing but incur $5,000 in closing costs. As a result, it will take you 25 months to break even.5 If you’re planning to stay in your home for two years or more, refinancing is a smart move. If not, it would be wiser to forgo refinancing so you don’t lose money.
· Boost a low credit rating before applying. You won’t be able to get a competitive interest rate with a low credit score. In this case, take some time to boost your credit rating to at least 620 (or 580 for an FHA loan) before applying for a refinance.
· Be sure to seek out multiple offers. If you take the first offer you get, you might miss out on a better deal. Instead, shop around. Get offers from at least three different lenders, so you can select the one who offers you the best terms.
Note: Applying for a refinance can temporarily reduce your credit score. To lessen the damage, a good tactic is to apply to multiple lenders in a short time frame, say between 30 and 45 days. This will count as a single inquiry and will have less impact on your score.
· Avoid so-called “no-cost” refinancing. This is a ploy to lure loan seekers. In reality, a no-cost refinance doesn’t exist. There are costs associated with refinancing, and lenders simply roll them in to your loan or charge you a higher interest rate to recoup these fees. You can still consider a no-cost refinance; just realize that you’re not really getting anything for free.
· Consider mortgage prepayment penalties. Before refinancing, ask your lender if you’ll be penalized for paying off your current loan early. If you will, find out how much the penalty will set you back so you can decide if the refinance is worth the cost.
· Rethink refinancing if you’ve already got a good rate. If you’ve already got a rate around 3%, refinancing may offer little benefit. To see if it makes financial sense, assess how much you’ll save each month and compare it to your closing costs and the interest savings over the life of the loan. If the savings is trivial, you may be better off sticking with your current loan and simply making extra payments against the principal each year instead.
· Assess the remaining lifespan of your current loan. If you’re within the last 10 years of paying off your current loan, the benefits might be too slight to make it worth the effort.
Is refinancing really worth it?
With interest rates at an all-time low, experts continue to trumpet the news that now is an ideal time to refinance your home—primarily, if you have steady income and your current interest rate is more than 4%. If this applies to you, refinancing could provide you with a way to lower your housing costs on a long-term basis.
However, you will want to put some effort into determining if refinancing is right for you. The best approach is to do the math and let the numbers tell you if the potential benefits outweigh the costs.
Have questions about how the interest rate drop may affect your finances? Let’s talk! Get in touch with me by replying to this email.
Sources:
1 - Backman, Maurie. (July 16, 2020). "The 30-year mortgage has reached a record low." The Ascent. Retrieved from https://www.fool.com/the-ascent/mortgages/articles/30-year-mortgage-has-reached-record-low/?utm_source=usa-today&utm_medium=feed&utm_campaign=article&referring_guid=349ea544-ae0d-47e0-b06e-181ef9745622.
2 - Investopedia staff. (Mar. 16, 2020). "When (and when not) to refinance your mortgage." Investopedia. Retrieved from https://www.investopedia.com/mortgage/refinance/when-and-when-not-to-refinance-mortgage/.
3 - Pritchard, Justin. (Mar. 10, 2020.) "What qualifications do you need to refinance a loan?" The Balance. Retrieved from https://www.thebalance.com/can-i-refinance-315504.
4 - Martucci, Brian. (Apr. 27. 2020). "When should I refinance my mortgage loan?" Money Crashers. Retrieved from https://www.moneycrashers.com/should-i-refinance-my-mortgage/.
5 - Backman, Maurie. (Aug. 16, 2020). "4 mortgage refinancing mistakes to avoid." The Ascent. Retrieved from https://www.fool.com/the-ascent/mortgages/articles/4-mortgage-refinancing-mistakes-to-avoid/.
6 - Gumbinger, Keith. (Feb. 8, 2013). "I have 3 years left on my loan, should I refinance?" HSH. Retrieved from https://www.hsh.com/refinance/i-have-3-years-left-on-my-loan-should-i-refinance.html.
