Should I Refinance My Mortgage?
It’s a question most homeowners ask themselves – ‘should I refinance my mortgage?’ During a time when interest rates are low and home values are still somewhat stable, it makes sense to jump on board and refinance your mortgage.
But how do you know when it’s right? What should you look for and which loan is right for you? It can seem confusing, but in this guide, we’ll walk you through what a refinance means, how to do it, and what you should look for to get the best results.
Check to see if you qualify first
If you’re thinking about refinancing, best bet is to see if you qualify first then see whether it makes sense to proceed.
What Does It Mean To Refinance?
First, let’s look at the basics. Understanding how refinancing your mortgage works and how it affects you long term will help you make the right choices.
Refinancing means you take out a new mortgage and pay off the existing loan that you have on your home. You do this to save money or tap into your home’s equity. Depending on your reason for refinancing, you can take out a few different types of loans:
- Rate/term refinance – When you refinance just outstanding principal balance on your current loan, it’s a rate/term refinance. In this case, you lower your rate, payment, or both. Most homeowners do this to save money each month as well as over the life of the loan. When interest rates are low, it’s a great time to take advantage of this program.
- Cash-out refinance – If you have equity in your home (you owe less than the home’s worth), you can tap into that equity with a cash-out refinance. You borrow more than the current outstanding principal balance. You may not save money each month, but you’ll get the difference between the current loan balance and your new loan balance in cash. When refinance rates on mortgages are low, it’s a great time to take advantage of this program.
Reasons To Refinance
We covered few basics above, you can refinance to lower your payment or take cash out of your home’s equity. Let’s take it a little further, though. Here are a few reasons to consider taking out a new loan:
Get The Best Refinance Rates
You’ve likely heard that the Fed dropped interest rates to 0% recently. While that doesn’t mean mortgage rates fell to 0%, they are still historically low right now, making it a great time to get great low rates. Even saving $100 a month, saves you $1,200 over a year and $36,000 over the term of the loan.
Take a look at your current interest rate and compare it to what you could get today. Will you save money each month? If you want to see if it makes sense to take the lower refinance rates on mortgages, use the following calculation to determine your break-even point:
Total closing costs/Monthly savings on the new loan = Break-even point
Let’s say, for example, you can save $150 per month with a lower interest rate and your total closing costs are $3,500.
Your break-even point would be:
Now think of your plans. Will you be in the home much longer than 24 months? If you will refinance now will help you save thousands of dollars in interest over the life of the loan which means refinancing makes sense.
Change Your Loan’s Term
Now is a great time to take on a shorter mortgage term. With today’s low refinance rates on mortgages, many homeowners can afford a shorter term. When you take a shorter term, you increase your principal payment since you pay the loan off faster. But, shorter term loans have lower interest rates, so it’s a win-win for you as you save money monthly as well as over the life of the loan.
If you can refinance from a 30-year term to a 15-year term, you knock the time it takes to pay your mortgage in half. That means you’ll own your home in just 15 years. There are other options, though, if the 15-year payment is too high – you can opt for a 20 or 25-year term too.
Get Rid Of Private Mortgage Insurance (PMI)
Are you currently paying PMI (private mortgage insurance) on your mortgage? If your home appreciated since you bought it, you may owe less than 80% of the home’s current value. If you do, you can refinance and eliminate PMI.
This works for government-backed loans too. For example, if you have an FHA loan, you pay mortgage insurance for the life of the loan. If you owe less than 80% of the home’s value, though, you can refinance into a conventional loan and eliminate the mortgage insurance, saving yourself thousands of dollars over the life of the loan.
Refinance Out Of An ARM
Did you take an adjustable rate mortgage (ARM) when you bought your home to take advantage of the lower introductory rate? Many homeowners do this to save money on interest at the start of homeownership. As you near the adjustment date, though, it can get nerve-wracking.
Your rate is tied to an index, such as the LIBOR. On top of the index, your lender adds the specified margin. Your new interest rate will be the current LIBOR plus the margin and your rate will change annually or monthly according to your loan agreement. This leads to unpredictability, which leads to difficulty with budgeting.
Whether your ARM adjusted already or you are still in the introductory period, you can refinance out the ARM and into a fixed rate with the best refinance rates available today.
Use Your Home’s Equity
If you owe less than your home’s worth, you have home equity. With the low interest rate environment today, it’s a great time to tap into that equity, if you need it. Homeowners use the equity in a variety of ways:
- Debt consolidation – Are you in over your head in consumer debt? Your home’s equity can help you consolidate it into one loan. With today’s low refinance rates on mortgages, it’s a great time to take advantage. You’ll lower the amount of interest you pay on your consumer debt and have only one loan to pay.
- Have emergency funds – If the pandemic has taught homeowners anything, it’s that an emergency fund is crucial. If you don’t have cash available in an emergency, tapping into your home’s equity and putting the funds in a safe place, such as a high interest savings account may be a good idea.
- Home renovations – What better way to reinvest the money you take from your home than to invest it right back into it? If you make renovations/repairs that improve your home’s value, you earn the equity back rather quickly by improving your home’s value.
- Pay other large expenses – Some homeowners use their home’s equity to pay other large expenses, such as college tuition, medical bills, vacations, or other large expenses that they’d otherwise have to put on a credit card or take out a loan.
Qualifying For A Refinance
Just like you had to qualify for a mortgage when you bought your home, the same is true during a refinance. You have to prove that you can make the payments and are a good risk. Each loan program and lender has different loan requirements, but in general, you’ll need:
- Good credit – Credit scores of at least 680 is often recommended
- Low housing ratio – Your mortgage payment shouldn’t exceed more than 28% of your gross monthly income (income before taxes) but this varies from program to program
- Low total debt ratio – Your total debts (credit card payments, personal loan payments, mortgage) shouldn’t exceed 50% of your gross monthly income (income before taxes)
- Stable employment – You should have minimum 2-year history of employment and your employer(s) must confirm that you are still employed
- Stable income – You must have a stable income over the last two years
Getting The Best Refinance Rates
How do you secure the best refinance rates available today? Lenders want to see the best qualifying factors. For example, the higher your credit score, the lower the rate a lender may offer. This doesn’t mean if you have a ‘lower credit score’ that you won’t qualify, though, you may just pay a slightly elevated interest rate.
If you do have any ‘negative qualifying factors,’ though, you can make up for it with compensating factors. In other words, give lenders a reason to see that you’re a good risk. Common compensating factors include:
- Low debt ratios (housing or total)
- Stable/increasing income
- Long-standing employment
- A large amount of assets on hand to serve as reserves
- The refinance will save you a significant amount of money
If you can benefit from refinancing, now is a great time to take advantage of the low refinance rates on mortgages that are available.
While lenders may have tightened up the restrictions slightly in the face of the pandemic, there are still plenty of opportunities to secure a favorable mortgage and get the refinance terms you need.