Featuring real estate articles and information to help real estate buyers and sellers. The Nest features writings from Georges Benoliel and other real estate professionals. Georges is the Co-Founder of NestApple and has been working as an active real estate investor for over a decade.
Since the pandemic, mortgage rates hit a record low. In 2020, a 30-year fixed mortgage rate was 3.86%, and now it has fallen to 2.96%, according to Bankrate. As such, many homeowners are taking this opportunity to refinance their home mortgage. The most common reason for refinancing your home is to receive a better interest term and rate. Other homeowners refinance to take out a sum from their equity and to replace their monthly mortgage payment with a longer repayment term. Lower interest rates not only mean saving money, but it also means paying down your principal faster.
Paying down your principal makes you carry less debt and gives you more equity or buying power. If you want to reduce overall expenses, refinancing your home loan is probably the right path for you. But there are drawbacks when you refinance. They include paying high-cost closing fees and costing you more in the long run when you refinance to lower payments over a more extended period. Also, an application fee and any other upfront fees are charged by the lender before you are approved for a loan.
You should always be sure you are in the proper financial position to take out a new loan. This means you need a high credit score, a steady job, and enough liquidity to ensure you can pay your new mortgage. So, while lower interest rates and smaller monthly mortgage payments may be what you’re after, there are always risks involved when you refinance. We’ll give you the lowdown on everything you need to know about refinancing. We will include why you should do so and when you shouldn’t.
Refinancing a mortgage is when you take out a new loan to pay off your original mortgage loan. Therefore, the new loan then replaces the existing one. The interest rate determines when you should refinance. If the interest rate is lower than your current rate, you should consider refinancing. The most recommended option is to refinance your existing mortgage down to a 15-year fixed-rate mortgage. The premise of refinancing your mortgage loan is the same as when you took out a loan to buy your home. Once again, you have to pay fees, taxes, and closing costs. And there is more than that, which we’ll discuss.
When you decide to refinance, your mortgage lender will determine your home’s current market value and look at your financials. These include your credit and tax return history and verifying your credit. If the lender feels you have enough finances to keep paying your new mortgage and property taxes, the lender will help you by offering you an interest rate lower than your existing one. The lender will also give you options to lower your monthly mortgage payment, borrow equity from your home and reduce the number of years on your loan.
But before you decide to refinance, you should wait for a considerable amount of time to improve your credit score if you have large debts. If you have manageable debt, you can wait a few months to pay it off. Keep in mind, the higher your credit score, the lower your interest rate will be from lenders. With a low rate, you can save thousands of dollars in interest.
You need to research to find a lender that has favorable terms. You should compare and contrast your loan options with different lenders. Remember you have a choice. You don’t have to refinance with your current lender. You should apply to as many mortgage lenders as you can. However, you need to consider how many times your credit is pulled when you apply to multiple lenders. The best way to find a reputable lender is by working with a mortgage broker who can recommend several lenders who will best meet your needs. Once you apply for preapproval with a lender, the lender will give you a loan estimate that lays out your refinancing costs.
Refinancing your home is just like the process you went through with getting your original mortgage loan. You need to fill out the loan application. You need to submit documentation. For example, these include pay stubs or copies of your bank statement. You need to await underwriting. An underwriter scrutinizes your finances to assess how much risk a lender will take if they decide to give you a mortgage loan. And finally, you need to close on your loan.
How long it takes to refinance depends on your lender. For example, if interest rates are low and the lender deals with a plethora of new applicants who want to take advantage of those rates, the lender may take longer to process your loan.
There are several reasons why homeowners consider refinancing their mortgage. Most people refinance when they have equity in their home, which is the difference between the amount owed to the mortgage company and the home’s worth. If your cost of living will increase because you have a baby or if your income has decreased because you took a better job but with less pay or laid off, refinancing may benefit you. If you want to buy stocks or reinvest in other properties, those are also valid reasons.
In a nutshell, here are the reasons why you should refinance.
Now here are the reasons explained, as well as other common ones.
The number one reason why many people refinance is to get a lower interest rate on their mortgage. If your current interest rate is higher than today’s rates, you could save money through refinancing. It’s often said that if mortgage rates are lower than your current rate by 2% or more, then it’s an excellent time to refinance. But even at 1%, that’s also a reason to refinance. When you reduce your interest rate, it helps you save money. Say your mortgage is $250,000 with a 6% interest rate. I
f you’re allowed to lower that rate to 3%, you save $400 each month on interest and principal payments alone, giving you extra cash that you can put toward your financial goals or savings. A lower rate means lower monthly payments. Not only that, you’ll pay less for your house overall.
With a lower interest rate on your refinancing, it’s possible to have your PMI removed. The PMI costs $300 to $400 a month on top of your principal and interest. If you get rid of the PMI, you save that money each month. This will work if your new mortgage is for 80% or less of the home’s current appraised value. PMI (Private Mortgage Insurance) protects the lender, not you, from defaulting on the loan. It is used when a borrower buys a home with a small down payment or less than 20%. Small down payments for lenders pose a risk.
Even if a homeowner has built up a high amount of equity, if you have used FHA or USDA loans, which are Federal government-backed loans, they may still require the homeowner to pay the PMI in the ongoing years to come. But if the homeowner has 20% or more equity, a conventional loan will no longer require the PMI. Thus, a conventional loan is better than a government loan. Homeowners who have a government loan often go out of their way to increase their creditworthiness and score so they can move to a conventional loan to get rid of paying the monthly mortgage insurance.
If you don’t want to make monthly mortgage payments each month in the years to come, you can refinance to shorten your mortgage length. If you convert from a 30-year mortgage to a 15-year mortgage—the recommended option to refinance, as we said earlier—you can pay off your loan faster or earlier. You save a lot of money in interest payments over the life of your loan and build equity in your home at a faster pace.
In the process, though, you will increase your monthly payment since your lender will require larger payments to pay off your balance in a shorter period. If you go this route, you should have a stable job or considerable income to pay that increase.
Also, keep in mind if you have an existing 30-year mortgage on your house and refinance with another 30-year term to reduce your monthly mortgage loan, it will take you longer to pay off your home, and you will end up paying more interest over the life of the mortgage loan. The length of your mortgage depends on your goals. Since some mortgage holders want to pay their loan sooner or want to pay less in lifetime interest, a shorter-term loan is ideal. But if you’re looking to lower your monthly loan payment, a long-term loan is usually best.
If you have over 20% equity in your house, you can use cash-out refinancing to borrow against your equity. A cash–out mortgage refinance when you borrow equity and get cash in exchange for taking on a larger mortgage. In essence, you borrow more than you owe on your mortgage and pocket the difference. Borrowing against your equity has several advantages. It gives you money to pay off debt like credit card debt and student loans, pay for school tuition or medical costs not covered by your health insurance, buy a new car, and even go on a much-deserved vacation.
The main reason homeowners cash out is to use the money to remodel their homes or make improvements. It’s done not just to update the house or give you more space but also to help you increase your home’s value.
Many homeowners use refinancing to consolidate debt to lower their overall monthly payments.
Suppose you have a mortgage with a riskier loan, such as an adjustable-rate mortgage (ARM). You can refinance and use a new loan with a fixed-rate mortgage. A fixed-rate loan may end up being higher. However, when loan rates increase, you’ll be secured. Essentially, moving to a loan with a fixed- rate can protect you from market fluctuations. Also, you’ll know what your monthly mortgage loan is every month, and you’ll have the same principal and interest payment every month. This will help you allocate funds for the future, so you’re never short on paying these fees. It will set you on a path to a good budget, so you’re never caught off guard where there are financial surprises. So, it’s a good thing to get out of an adjustable-rate mortgage. However, if rates drop, you won’t be able to take advantage of that without another refinance.
You need to figure out how long it will take for monthly savings to recoup your refinancing costs. Factor in your closing costs: on average, 2 to 5% of the loan amount and any fees related to the refinancing. To see if you’re saving enough is to calculate your “break-even point,” which is how long it will take your savings from a lower mortgage rate to exceed your closing costs. So, if your closing costs cost $4,000 and include lender, title, and third-party fees, and you are saving around $200 a month, your break-even point would be 20 months. You will save money every month after that. You can use a refinance break-even calculator to determine how long this would be.
If you refinance, you have to consider it takes a lot of money. Once again, you have to pay upfront fees and fees to the lender to initiate a loan and closing costs. Closing costs include origination fees, application fees, lawyer fees, loan origination fees, underwriting fees, taxes, mortgage insurance fees, and other closing fees.
Because the cost of most homes and their value has declined over the past decade, you also need to pay for a new appraisal. Without an appraisal, your refinancing lender may be unwilling to give you a loan more than your house is worth.
Also, you need to pay the fees below:
The high fees for the closing cost can make you think twice about refinancing. But note that the bright side is that you can roll in these costs with your new loan. The mortgage lender Freddie Mac suggests you will spend around $5,000 during closing. But that’s a low-ball figure. Most homebuyers end up paying over $10,000 and up to $15,000 and more because Freddie Mac doesn’t include such things as home inspections and application fees when coming up with a round-about figure of closing cost fees.
Lenders will determine how much you spend on closing costs by assessing the area around your home, the home itself, and your credit score. Remember, when you close, you need to pay upfront all the associated fees. If you can’t afford these costs, you may not be ready for refinancing.
When you check rates with a lender, the lender will run your credit report. As we mentioned, you should always look at multiple lenders to get the best interest rate, but the downside is that your credit score will be affected. This happens because your credit pull is a hard inquiry, and, as such, your credit score will dip by a few points. However, you can avoid multiple hard inquiries using smart rate shopping and getting all your applications in during a 14- to 45-day period. While it depends on the type of loan you receive, this reprieve may only count as one single inquiry when your score is calculated during that period.
One of the reasons to avoid refinancing is it takes too long for you to get back the closing costs on a new loan. This is your break-even point, and once again, it’s the number of months it takes to reach the point when you start saving. When you lengthen the life of your loan by many years, your break-even point will be cast further out in the distant future, making it longer for you to get back your closing costs on your new refinancing loan.
When you refinance to lower payments over a longer period, you are lengthening the time it takes to pay off your loan. It may cost you more in the long-term because interest is compounding, despite the fact you are reducing your loan rate.
Cashing out your home equity gives you more cash at hand to make home improvements or to buy major purchases like a new car. But you’ll reduce your home equity and increase your new loan balance. And because you are resetting your loan term, you’ll end up paying more in total interest.
If you decide to reduce your balance earlier than your loan term, some mortgages have prepayment penalties. To avoid this situation, you need to know all the terms and conditions of your new loan before closing.
If you found your ideal lender, your closing costs and attendant fees may vary. The median rate is roughly 2-5 % of the loan amount but often can be more than that. Here’s what you need to qualify for the new loan. Just like with your original mortgage, your potential lender will take into consideration the following.
There are many reasons why a lender won’t allow you to refinance your mortgage. The most popular reasons are as follows.
You need to have a steady job. A stable job to a lender means you have a steady income. You should have at least two years of employment in a row in the same position at your job. If there are gaps in your job history, or if you keep switching jobs, a lender may deny you a new loan. However, a lender may give you a new loan if you have a new job. But only if it’s the same profession as your former job.
The lender will require you to have enough cash on hand and little to no debt while paying your new loan. If you don’t have enough liquidity or back-up money in your savings, the lender will once again deny you. To prove you have sufficient income to pay your new mortgage, the lender will want to see your bank statements for the last two months. It depends on the lender.
Having more debt than cash is a no-no. The debt-to-income ratio is one of the most critical factors that the lender will look at.
If your credit score took a hit, you might not qualify for the refinance loan. The underwriter will want to see a credit score above 700. If it dropped to, say, 650, this might hinder you.
To determine if refinancing makes financial sense for you, you should use one of the many mortgage refinance calculators found online. To see if you will have potential savings, you’ll need to factor in all the costs related to refinancing your loan, such as the dreaded closing cost and more. If you have less than 20% equity, the lender will require you to have mortgage insurance if you default on the loan. So be sure to add mortgage insurance, which is expensive, to your costs. Once you determine your new loan’s interest rate, that’s when you can calculate your new monthly mortgage loan payment to see how much you will be saving each month. If you don’t have savings, then refinancing right now is not a good idea.
You’ll also want to be sure you have enough equity in your home, which is usually 20% equity. To determine how much your house may appraise, make sure you compare comps with similar houses in your neighborhood or check your area’s property values. You can also use real estate portals like StreetEasy or Zillow to determine the cost of your home. A real estate agent can quickly determine your appraisal if you use one for consultation.
Once you have a good idea of refinancing costs, you can compare your new monthly payment with what you currently pay.