With interest rates falling to close to all-time lows, you may be thinking about refinancing your mortgage. But you may be wondering if that’s a good idea and how to decide if it’s a good financial move at this time or not. In this article, we are going to give you the indicators you need to pay attention to that will help you decide if this is a good move for you.
First of all, let’s define exactly what refinancing is. The refinancing process involves paying off the current mortgage you have on a property and opening a new mortgage at a different interest rate. The goal in most cases is to get a lower overall interest rate that will lower your monthly payments and the overall amount you pay for the home (when you include interest).
The other important thing to consider is that refinancing can be used to roll other loans into the mortgage and take advantage of any equity that you may already have in the property.
For a great article explaining these key points go to https://www.investopedia.com/mortgage/refinance/when-and-when-not-to-refinance-mortgage/.
Before you jump into a refinance feet first, there are a few key points that can be strong indicators about whether a refinance is a good financial option for you at this time.
So the number one reason most people refinance is to get a lower interest rate, so the number one indicator is when interest rates go down. When rates drop to near market lows refinancing is a real opportunity for you to save thousands of dollars, and this is an important time to take advantage of this opportunity.
Part of this process will require you to take the time to shop around and find the best mortgage provider that has the ability to give you the very lowest rates available.
For help finding the right mortgage provider go to:https://www.nerdwallet.com/best/mortgages/tips-for-finding-best-refinance-mortgage-lender
The other key here is to know if you currently have an adjustable-rate interest mortgage or a fixed interest rate mortgage FRM). An adjustable-rate interest mortgage (ARM) means that the interest rate you are paying can change periodically as the market changes. As you can imagine, it's not a very advisable type of mortgage to have, and one great reason to refinance is to get out from under an ARM and into an FRM at a really low-interest rate. This will stabilize your payments and potentially save you thousands of dollars over the course of your mortgage.
Another way to save thousands on a refinance is to shorten the length of your mortgage. Doing this may cause higher monthly payments, but the overall amount you end up paying back on the mortgage loan can be significantly smaller.
Let’s say you have a 30-year mortgage and you discover you can get a much lower interest rate on a 15-year note. A refinance while raising your monthly payments will dramatically reduce the amount you pay overall because of the massive reduction in interest and cutting the number of payments in half.
Another key indicator is equity. If the value of your home has increased because the market values have changed, you could take advantage of a cash-out refinance, which will allow you to take cash out of your equity NOW while at the same time taking advantage of a lower interest rate if that is available.
Another concern is your PMI or private mortgage insurance that you may have been required to purchase. If you were unable to put down 20% at the time of purchase, the mortgage company likely required you to carry private mortgage insurance. However, in most cases, once the equity has grown in your home, you can refinance and drop those pesky PMI payments altogether.
Now, here are some things to think about that might not be in your favor for refinancing.
First and foremost, how long will you be in the home? If you are not planning to live there long term, it’s unlikely that the reduction in monthly payments and reduced interest rates will be of much benefit to you. The key is that you need to be staying long enough to recover the refinance costs. That is what is referred to as the break-even point. If you are not planning to stay long enough to reach that break-even point, it is really not very beneficial for you to consider a refinance.
Sometimes the short term benefits are not worth the long term costs. If you have a 30-year mortgage and you’ve been paying on it for five years, and then you refinance at a lower rate for another 30-year note, you are basically starting over from scratch. Yes, you lowered your monthly payments, but you also extended the number of payments another five years because you refinanced at 30 years again.
And then if you factor in the additional closing costs and other sometimes out of pocket costs, it can really end up being a wash in the long run.
While we are at it, the other thing to think about here is the closing costs overall. In many cases, they can be rolled into the new loan, but they can still be quite sizeable, and when everything is said and done, they can cause your savings to become almost nonexistent.
Another concern is a little-known fee some lenders use that is referred to as the prepayment penalty. This fee is usually based on what is called a prepay penalty term and does not extend to the entire life of the loan. However, the fee can be very hefty, often being 80% of six months of the interest on your original loan. If you are not out of the prepay penalty loan period, you should likely wait until that time has cleared.
Sometimes tapping into the equity of your home via a refinance is not a great idea. Think about this; you have maxed out all of your department store and credit cards, you are barely getting by and drowning in debt, then suddenly the value of your home increases, and you have a nice bit of equity. So you start thinking that equity would be a great opportunity to get you out of debt.
By the same token, you must be honest with yourself. If you haven’t been able to curb your spending or your income is not increasing, you could do this and then easily turn around 6-12 months later and be right back in the same boat. Only this time, all your equity will be gone.
Another important factor to consider in refinancing is your personal credit score. If your personal credit score has gone up even as little as 20 points, it can lower the interest rate on a refinance and create huge savings for you of thousands of dollars.
The minimum credit score requirements vary from lender to lender but normally fall between 600 and 640. Here are some of the current bottoms scale interest rate requirements:
FHA cashout and streamline - 600
FHA standard refinance - 600
Conventional cash-out refinance - 640
Conventional/standard refinance - 620
Another thing to consider is how quickly, after the purchase of your home, you can do a refinance. There is no law or set time, but most experts say you should wait until you at least have a little equity built up in the property. The main reason is if you don’t have much equity in the property and have a high debt to loan ratio, lenders are automatically going to offer higher interest rates, which will be utterly counterproductive to what you are trying to accomplish in most instances.
The other thing of note here is that waiting at least several months allows the potential new lenders to see that you are making the payments on time and keeping current, which will give you that much of a better chance to get a lower interest rate.
Another key factor to take into account here is the amount of interest you will actually be able to reduce. This can get a little tricky because if your mortgage is only for, say, $200,000, then a 1% reduction isn’t really going to amount to too much actual savings. However, if you have a $1 million mortgage, then a 1% interest rate reduction will be quite a bit of extra money back in your pocket.
To figure out how much you can save, just use this handy mortgage interest calculator located here:
https://www.nerdwallet.com/mortgages/refinance-calculator
Also of note is how long this process can take and all the headaches involved. Typically a refinance is done in 30-45 days. However, in some cases, it can take longer. Another important thing to think about is all the paperwork required by the mortgage company to do the refinance. The following are the key pieces of paperwork you will need:
Proof of income
Two months of bank statements
Profit/loss statement if self-employed
Bankruptcy paperwork if needed
Two years of W-2’s
And there could be even more depending on your current situation. Gathering all of that together can, at times, be a real headache.
The most important part of this is to make sure you take your time and find the RIGHT mortgage lender that can offer you the best rates and the best customer service. They should be able to answer all your questions and help you with the process to make the entire thing a win/win situation.
Take a good look at the indicators we have outlined here, and then decide for yourself if refinancing is in your best interest or not. There are many factors to take into account, so be informed and take your time. It could end up being one of the best financial moves you ever make.