Before refinancing your home to get a more favorable interest rate, there are several things to consider. If the timing is right, you can save a significant amount on your monthly payments.
What We'll Cover
- Start By Prequalifying For A Refinance
- Look Up Your Current Home Equity
- See If Your Mortgage Comes With A Prepayment Penalty
- Check Your Credit Score With the Actual Credit Bureaus
- Be Aware Of Your Current Credit Score and Find Out If There Are Quick Ways to Improve it
- Debt-To-Income Ratios Matter Too
- Focus On The Current Interest Rates
- Consider Shorter Terms
- Some Types Of Homes Do Not Qualify For Low-Interest Rates
- To Compare Lenders: Look At The APR Rates
- Read The Fine Print With "No Cost" Or "No Points"
- Automated Qualification Systems Are Tweaked Often
- You'll Have To Prove Your Employment Status
- Refinancing Comes With Closing Costs
- Paying Points On Your Mortgage
- Know The Difference: ARM, HELOC, Or Fixed
- The Case Against Taking Cash Out
- How Long Does Mortgage Refinance Take?
- You May Qualify For A Refinance Tax Deduction
- Raise The Appraisal Value Of Your Home
- Hire An Attorney
- The Only Way To Get Out Of An FHA Loan
- Avoid Opening Up New Loans During Refinancing
- Final Thoughts
Lenders look at various factors to determine your interest rate; chief among them are debt-to-income ratios, credit scores, and the type of home that you are financing. You are invited to continue below to learn more about whether refinancing your mortgage could be a good move.
Start By Prequalifying For A Refinance
You can get an estimate of refinancing costs and the available loan terms by prequalifying for a refinance. This makes it easy to compare mortgage plans across several lenders.
You should limit your options to a few different lenders. Getting prequalified with a larger number of lending firms may hurt your credit score while applying to too few will lead to you possibly missing out on the best deal. Use BestRates to compare refinance rates from multiple lenders by clicking on the button below:
Once you have selected a few different lenders for prequalification, your next step should involve researching the market value of your home. You can find this by visiting real estate websites that show listing data or searching property assessor data.
Look Up Your Current Home Equity
Equity is the current value of your house, which fluctuates not just from year to year, but from quarter to quarter as well. Many lenders will not allow you to refinance your home if you have low equity.
For those with lower equity, you may be able to find assistance in the form of government programs. One program that comes to mind is to streamline refinancing an existing FHA-insured mortgage. You can read up more on the program on the HUD website.
See If Your Mortgage Comes With A Prepayment Penalty
Many lenders apply a prepayment penalty to mortgages. They would rather have you pay slowly over time than paying everything in a short duration. Consistent payment in full demonstrates financial stability.
When you are either applying for a loan or refinancing, you should see whether there is a prepayment penalty. Specific circumstances in which penalties may apply include annual payment exceeding 20% of the total loan amount, selling, or refinancing.
Check Your Credit Score With the Actual Credit Bureaus
I know, we all love to use free services; such as Credit Karma and Mint to keep an eye on our credit scores, but did you know that most of the credit bureaus now provide you with free credit reports as well? These credit bureaus can often provide more in-depth information about what’s on your credit report that other free services can’t. After all, they are the ones with your actual credit file. A few years ago I hired a credit repair agency to help me boost my credit score and the first required step in the process was to get a full report from the actual credit bureaus. Refinancing is a very important financial decision, so you want to get a full credit report from the bureaus. Click on the links below to get it for free:
Be Aware Of Your Current Credit Score and Find Out If There Are Quick Ways to Improve it
Credit scores matter more now than they did in past times. Even if you have a good credit score, you may not qualify for the lowest interest rates. Lenders tend to set a benchmark score of 760 for the premium interest rates.
To eventually qualify for these lower scores, there are many things that you can do to build up your credit score.
- Use Experian Fico Boost®. Experian has a free service where you can boost your credit score for free by adding to your score the on-time payments you’ve made for services that don’t report to the credit bureaus, such as your cell phone and your netflix bills. Check it out here!
- If you don't have much of a credit history, you may establish credit with a credit-builder loan from a bank or credit union.
- Establish a good payment history by paying all loans on time and in full.
- You can add monthly bills to your credit report. These are not typically factored into your credit score unless you enlist yourself in a special program that counts monthly bills towards credit scores.
Debt-To-Income Ratios Matter Too
The goal is to keep house payments to 28% of your gross monthly income (your pre-tax wages). Other than a high income, factors influencing the interest rate can include a stable job history (not moving from company to company) and substantial savings.
You should also not have too much existing debt if you are going to successfully refinance your home. If you just started payment on a significant auto loan, this may not be the best time to refinance your home.
Focus On The Current Interest Rates
The current interest rates will at least partially determine whether refinancing your home is a smart move at this juncture. As a general rule-of-thumb, ready yourself for refinancing as soon as the interest rate drops at least half a percentage point from the rate you are currently paying.
The year 2020 saw historically low interest rates, hitting 2.72% with a 20% down payment and a 30-year fixed mortgage. Under equivalent qualifiers in 2019, the rate was 3.66%, according to Freddie Mac.
Consider Shorter Terms
You might consider refinancing to a loan with a shorter term or expiration date. A loan specialist will provide you with several combinations of rates and term lengths.
- With a shorter term, your monthly payments will be higher.
- Your interest rates will be lower.
If you want to pay off a mortgage quickly, look for the shortest term that is practical. You can always include added principal during the payment process.
Why Would You Want To Refinance To A Shorter Term?
For homeowners with a tight budget, it wouldn't be wise to refinance to a shorter term. This could require you to pay a few hundred extra dollars per month. If you fail to make your payments at any point, it will hurt your credit score.
If you have very few long-term debts (student loans, car payments, etc.) and a higher income level, refinancing to a shorter term could be a good move. You'll need to decide whether it's better to build home equity, or potentially contribute to a retirement account or further your investment portfolio.
Some Types Of Homes Do Not Qualify For Low-Interest Rates
The type of house you live in will count towards the magnitude of your interest rate. Please be advised that vacation homes and condos, in particular, do not typically qualify for the lowest rates in the current market. Lenders categorize these as being riskier properties.
If you do own a condo or vacation home, your best bet is to shop around as much as you can with different lenders. Some institutions are more comfortable than others with riskier properties such as condos and vacation homes.
To Compare Lenders: Look At The APR Rates
The APR is the "annual percentage rate," a parameter that includes both interest rate on the loan and the total cost of the loan once it is amortized across the term period. Use the form at the top of this article to check the current refinance rates in your area:
You can search for the current benchmark refinance rates on websites like this one. This will show a benchmark 30-year refinance rate, the average 15-year refinance year, the ARM rate, and the APR. This will give you a good idea of what you can expect, provided that several factors will influence the final rate.
Read The Fine Print With "No Cost" Or "No Points"
Some lenders may offer applicants "no-cost" or "no points." This terminology doesn't necessarily mean that you are getting a better deal, since lenders can just as easily hide those additional costs in categories like loan or origination fees. This furthers the importance of comparing lenders with APR rates, not tricky marketing maneuvers.
Automated Qualification Systems Are Tweaked Often
These days, borrowers qualify for loans that are determined by a plug-and-chug calculation that is often tweaked by lenders. So, you may not qualify for a loan that you would've qualified for a year ago or vice versa.
A real-life example of this took place in 2020. Although interest rates were low, the data from the Mortgage Bankers Association revealed that many lenders tightened credit availability out of concern for the state of the job market at the time.
You'll Have To Prove Your Employment Status
If you are currently in between jobs, then right now would not be the best time to refinance your home. Lenders ask for verification several times throughout the refinancing process. They use income and employment data to determine how much of a liability any given applicant is.
Refinancing Comes With Closing Costs
Borrowers are required to pay closing costs every time they refinance. This payment can come in either the form of cash or an update to the loan balance. Even if mortgage rates are low, refinancing may not be the best move given your current fiduciary status.
How To Calculate The Break-Even Point
You can calculate the time it will take to recoup closing costs. This is commonly referred to as the break-even point of a refinance. Simply divide the total loan costs by the monthly savings.
Here's a working example:
- A homeowner will save $75 a month after refinancing their home.
- Their closing costs total $2,500
- The resulting break-even point is 33.33 months.
After 33.33 months, the homeowner will have paid off their closing costs and begin saving money from the point forward. This goes to show that it can be several years before you begin to save money on a home refinance. The average closing cost in America is $4,345.
Paying Points On Your Mortgage
In the lending industry, points are fees paid directly to a lender at the time of closing in exchange for a reduced interest rate. If you've ever heard of the phrase "buying down the rate," this is what it is referring to. The standard is for each point the borrower buys to cost 1% of the total mortgage amount.
On average, you can expect to lower the rate by 0.25% for each point purchased. You also don't need to buy points in whole numbers. Fractions of points can be purchased as well.
Purchasing points can be beneficial if you can recoup the cost by doing the following:
- Stay in the home long enough to recoup costs.
- Avoid refinancing your home again anytime soon.
- Don't pay off the mortgage ahead of time.
If you can see yourself living in your current home for quite some time after refinancing your mortgage, then you may be able to save money by buying points.
Know The Difference: ARM, HELOC, Or Fixed
An ARM is an adjustable-rate mortgage. These tend to come with lower interest rates versus fixed-rate mortgages. These are handy for homeowners who don't anticipate staying in their homes past the fixed term of the loan.
A HELOC is a home equity line of credit. You are borrowing against the available equity in your home, with the house itself being used as collateral for a line of credit. You do have to have equity in your home to qualify, meaning that the value of your home must exceed the value of your home.
If you apply for a mortgage with a fixed interest rate, then you are locked into the interest rate shown in the loan agreement unless, of course, you decide to refinance your home at a later date.
The Case Against Taking Cash Out
One of the common reasons that homeowners refinance their mortgages is to cash out on their home equity. Think about this: Your home is worth $300,000, and you only owe $150,000. A refinance to $200,000 would leave you with $50,000 in cash.
If interest rates are low, this is a cheap and effective way to borrow money. This is not without consequences, though, since you have simultaneously increased your mortgage and decreased your home equity.
This is a maneuver that requires careful consideration. If you’ll use the money for a well thought out investment or have to pay off high-interest credit card debt, then this can be beneficial. Otherwise, you may end up losing money in the end. This is why you are encouraged to seek the advice of finance professionals, who should present you with a myriad of possible solutions.
How Long Does Mortgage Refinance Take?
It may take up to 30 days to refinance your mortgage. You will likely need to go through the application process, underwriting, a home inspection, an appraisal, and then the closing process. As you can probably imagine, it can take 30 days or even more before everything is said and done.
This is why you are encouraged to get your affairs in order ahead of time. Gather and organize all the documentation into a binder before you visit the office. Ready your home for an inspection so that you will qualify for the low interest rate you desire.
You May Qualify For A Refinance Tax Deduction
Current tax policies, set by the government, influence which deductions you may or may not qualify for. Typically, the biggest tax deduction you can qualify for will be the mortgage interest deduction, which can be applied to both the original loan and the refinanced loan.
There are two types of mortgage interest deductions:
- Standard Rate-and-Term Refinance
- Cash-Out Refinance Interest Deductions
You can opt for cash-out refinances as long as you take equity out of your home to make a capital improvement. This includes home projects like redoing the driveway, replacing a roof, and much more.
Raise The Appraisal Value Of Your Home
If you plan on refinancing your home, this would be a good time to complete any home makeover projects that you've been considering. Even just a clean yard and garden can make a difference.
Any maintenance issues inside the home need to be taken care of before the inspection. A fresh coat of paint and new carpeting are examples of affordable interior renovation projects that may bump up the appraisal value of your house.
Hire An Attorney
There is a chance that your state requires you to hire a real estate attorney during the refinancing process. Even if it is not required by law, you may still consider hiring a real estate attorney ahead of a refinancing push.
An attorney will know about mortgage terms that will get thrown around by the lender. They will speak on your behalf as you attempt to navigate through some potentially challenging financial decisions.
The Only Way To Get Out Of An FHA Loan
There are only two ways to move from a Federal Housing Administration (FHA) loan to a private loan: either sell the home or refinance your mortgage. Once you have built enough equity, it will make sense to transition to a private mortgage for the improved interest rate.
If you are currently on an FHA loan and have built equity, you are certainly encouraged to refinance your home. By transitioning to private mortgage insurance, you will no longer need to pay the premiums that come with the FHA loans.
Avoid Opening Up New Loans During Refinancing
As soon as money frees up, the instinct is to start spending more. You may be inclined to purchase a new car or open a new credit card. These are things that should be avoided as you are attempting a refinance.
Lenders usually check a credit report multiple times during the application stage. If any inquiries or new debt pops up, this may slow down the approval process and also affect your ability to qualify for a lower interest rate, which is one of the primary goals of refinancing in the first place.
If you are considering a refinance of your mortgage, start by comparing a few different lenders. The critical point of comparison to focus on is the APR or annual percentage rate. Lenders may use terminology like "no-points" or "no-cost" to give the impression that they are offering a better deal. BestRates is a service that works like Trivago for mortgage refinancing. It helps you compare rates from multiple lenders and aggregators in one place. To check out your options click on the button below:
There may be hidden fees elsewhere though, so the primary focus should be the APR and the term. From there, you should calculate the break-even point, which is described in further detail in the sections above. This essentially allows you to determine the point at which a refinance will begin to save you money on your monthly payments.