Mortgage rates are close to the lowest they’ve ever been, which has prompted many homeowners to take advantage and refinance their mortgage. However, a refinance is a lengthy process that must be handled responsibly. Part of properly managing the refinance process is making sure you do it at the best time. Many people are quick to want to refinance because of these low rates, but is now a good time? That answer depends on a bunch of factors. The big question is when should you refinance?
People usually don’t think of a home refinance until they see mortgage rates are low. However, there are plenty of other reasons you could refinance your mortgage. Oftentimes other homeowners will refinance because they want to pay off their loan more quickly, build the amount of equity they have in their home, get cash out of their home, or reduce their monthly payment. It’s important to understand good times to refinance to see if your situation applies. This can help you make a more educated decision
Understanding a Good Mortgage Rate
In order to understand what makes a good mortgage rate, you must understand what a mortgage rate is first. A mortgage rate is the amount of interest that lenders charge borrowers. This is the interest rate on your mortgage. These interest rates are always changing due to many factors. Factors like market changes, the economy as a whole, inflation, global influence, the Federal Reserve, and more all impact this rate. When you see these low rates associated with refinances, it is important to not get too excited. The advertised lowest interest rate may not be applicable for you as a borrower. Some major influencing factors of refinancing a mortgage are the amount of equity you have in your home as well as your credit score and income. People that refinance due to mortgage rates go for a rate and term refinance.
Mortgage Rates and Refinancing Your Mortgage
The general rule of thumb when it comes to refinancing is that it makes sense to refinance when your interest rate reduces by 2%. However, lenders argue that if your rate drops at least 1% then it is worth the refinance. Even though this is the rule of thumb, it doesn’t necessarily mean it has to be followed. For example, even though generally people say to have a 20% down payment on a home, there are plenty of down payment options for way lower than that. Just because it is a generality does not mean it is a strict guideline! There are formulas that can help you determine if it’s worth it to buy a home. This is called your break even point.
Your break even point is the point where your savings exceeds the cost of the refinance (they aren’t free!). You can figure out your break even point by dividing the overall loan costs by the amount you save every month. There are also free online tools that are available to use whenever. Many people are often surprised to find out that it may take years to reap the full benefits of their refinance. Which is why other factors like how long you plan to stay in the home are important to consider.
What are the Costs of Refinancing Your Mortgage?
Some homeowners may be surprised to learn that there are some hefty costs associated with refinancing a mortgage. There are plenty of costs that you may encounter. These can include:
- Location of the Property
- The Loan type
- Amount of the Loan
- Appraisal Fee
- Title Fees
- Recording Fee
- Legal Fees
- Credit Report Fees
- Mortgage (Discount) Points
- Prepaid Interest Charges
Sometimes lenders advertise no closing cost refinances. While this may seem like a great deal right out of the gate, it is actually a bit more in depth. You do still have closing costs with a mortgage refinance. However, instead of paying these fees and costs upfront, you can roll them into the total amount of your loan. This will also impact your total loan amount which can have an affect on your true break even point.
Can You Refinance for a .5% Decrease on Your Home?
There are no restrictions when it comes to refinancing your mortgage. Mortgage rates could drop as little as .5% below the rate that you currently have. If that happens, it still may be worth it to refinance in specific situations. Your break even point will be a true determining factor amongst many others. You also want to keep in mind how long you plan on staying in the home, and realize that refinancing at .5% means less savings than if you waited for mortgage rates to drop even lower. These interest rates are always changing so don’t get stuck on one interest rate you like right away.
Refinancing to Pay the Loan Off Faster
Other homeowners take interest rates into consideration, but primarily focus on refinancing their mortgage to handle their debt faster. When you refinance you can change the loan terms (length of the loan). Usually people buy their home with a 30 year mortgage. If a person decides to refinance after 8 years then that means there are still 22 years remaining on the loan. Refinancing a mortgage can provide the opportunity to change those loan terms to a 15 year loan. This means that the borrower essentially shaved 7 years off of the length of their loan. If the main goal is to update the loan terms and save money then borrowers go for a rate and term refinance.
Build Equity in the Home
Sometimes people don’t care about the mortgage rate or their loan terms. Instead they are looking at their loan to value ratio (LTV). This LTV is important, especially when it comes to your private mortgage insurance (PMI). Depending on the type of loan that you have, there may be some rules about having a PMI. In a conventional loan, borrowers are usually able to get rid of their PMI when they reach a LTV of at least 80%. Borrowers can do this with a cash in refinance.
Get Money From Their Home
Another popular motivation people have to refinance is to get money out of their home. People will earn equity as they pay off their loan. This equity is not liquid cash that can be accessed at any time. Instead, people can access this with a home equity line of credit (HELOC) or with a cash out refinance. Borrowers typically use the funds that they receive towards debt consolidation.
Reduce the Monthly Payment
A reduced monthly payment can provide a world of opportunity when it comes to managing your finances. That is why many homeowners choose to refinance their mortgage for this reason. When you refinance you can access a lower mortgage rate. These reduced interest rates paired with other factors like a good credit score can result in some serious monthly savings. You may be able to get a lower monthly payment with many different types of refinances.
Types of Home Refinances
There are plenty of types of home refinances. However the three popular options are:
- Rate and Term Refinances
- Cash In Refinances
- Cash Out Refinances
Not every refinance is created equal. Your motivation to refinance will determine which would be a good fit for your financial situation.
Rate and Term Refinances
This option is popular amongst homebuyers that want to get an improved interest rate or improve their loan terms. In this refinance, the loan amount is based on the balance of the current loan you have. When people get an improved interest rate on top of better loan terms then their main goal is to usually save money. People usually improve their interest rates by getting a better mortgage rate or changing their interest terms.
There are two types of interest terms when it comes to a mortgage. There is an adjustable rate mortgage (ARM) or a fixed rate mortgage. When you have an ARM, the interest rate is variable and constantly changes. This lack of stability can make it hard to manage your money. On the other hand, when you have a fixed rate mortgage, the interest rate stays the same. This results in the ability to better budget your finances.
Cash In Refinance
This is the opposite of a cash out refinance. This home refinance option includes providing extra cash during closing in order to reduce the overall amount owed to the bank. This can improve the borrower’s LTV and result in the ability to get rid of their PMI. This can result in more savings every month and/or over the course of the loan.
Cash Out Refinance
Borrowers that want to get money out of their house opt for a cash out refinance. When you own a home, you build equity. In order to tap into the equity that you own you either need a HELOC or a cash out refinance. Instead of the amount being based on the balance of your current mortgage, it is based on the total amount of the home (this includes the equity that you own). These funds are generally given to the borrower during the closing.
Even though the main goal of this refinance is to get cash out from your equity, you can still get a reduced interest rate and better loan terms as well. This can be a win-win-win! However, these refinances pose a higher risk for the lender. This means that lenders will typically only provide this option to borrowers that have at least 15% to 20% of home equity available.
Other Factors to Consider
One of the biggest factors that will impact your home refinance is your credit score. If your credit score improved since you bought your home then you may be pleasantly surprised with the savings you face. The better the credit score then the better the interest rate. The better the interest rate then the more savings over the lifetime of the loan. This could even help you achieve your break even point sooner.
If your credit score decreased then that may be a different story. You typically need a credit score of 620 in order to qualify for a mortgage refinance. However some loan options can accept scores as low as 580. Each financial institution has their own eligibility criteria for borrowers. You can check your credit score for free with your financial institution and you get one free annual credit report.
If you find that your credit score isn’t up to par you may benefit from some credit improvement before a refinance. Making consistent, on time payments can help improve your score. If you see any errors on your credit report then you should dispute it as well. You may be able to get items dropped from your report and remove the impact to your score.
Commonly Asked Questions
Understanding when the best time to mortgage refinance can be difficult to find at first. That is why many homebuyers have questions. Some of these questions may be able to provide you more insight.
When Should You Refinance Your Mortgage?
This answer is based on the factors listed above like the mortgage rate, your current mortgage structure, your motivation to refinance, your credit score, etc. Taking into consideration the time, cost, and energy that goes into a refinance can help you find your break even point. For example if you could reduce your mortgage rate by 2%, change your mortgage from an ARM to a fixed rate mortgage, reduce your loan term, your credit score improved, and find your break even point within your remaining residency of the home then it would make sense for you to refinance your mortgage now. Obviously there are plenty of other situations where a mortgage refinance is still worth it, this is just an example of an obvious sign to refinance.
When Should I Consider Refinancing My Home Mortgage
You can begin considering the mortgage refinance process whenever you want. However, when you are looking for a lender for your refinance, you need to handle this responsibly. You may find that you want to get multiple estimates for your refinancing. This can result in submitting hard inquiries. Credit bureaus are aware that consumers can comparison shop when trying to find a home lender. That is why they typically allow a window of time for consumers to submit multiple hard inquiries and have them only count as “one” in how they impact your credit score. Each credit bureau has their own guidelines into what is considered to be one hard inquiry. Some allow 14 days while others allow 45 days. It is best to err on the side of caution and keep your hard inquiries within the span of 14 days. This means if you are going to seriously consider a refinance, you only have two weeks to do so to keep the impact of your score to a minimum.
Is a Fixed Rate Mortgage Better?
It can be. When you have a fixed rate mortgage, the interest on your home loan is fixed. The other option is an ARM that has a variable rate that can either go up or down. A fixed rate mortgage is nice because it provides stability. When you know what you will be paying every month it is easier to budget more efficiently. Proper budgeting can mean you make the most out of your finances which can lead to higher savings.
Should You Refinance for a Lower Monthly Payment?
You can’t just focus on one factor when determining if you should refinance your mortgage. There are plenty of other considerations. However, if everything works out and you still are able to get a lower monthly payment then you should get a mortgage refinance.
How Important are Interest Rates When it Comes To Refinancing a Mortgage?
Your interest rate plays an important factor in your mortgage. Your interest rate can cost you thousands over the course of the loan. That is why it is important to find your break even point to see if the cost of the refinance is worth the savings. If your interest rate isn’t better, you may not be able to see any type of savings that are substantial.