Refinancing your mortgage can be a great, money-saving option for many homeowners, especially if your credit score has improved and you’re refinancing for a lower interest rate. However, there are also associated costs that must be considered, including fees which can range from 2% to 5% of your balance due.
Could this be a great time to refinance? How soon can you take advantage and possibly get into a lower rate? Even if you can refi, does it make sense for you? Learn how refinancing works, the benefits and drawbacks to refinancing, when the right time to refinance is, and if it’s the right option for you based on your financial goals and what you are looking to accomplish.
How Mortgage Refinancing Works
When you refinance, your current loan gets paid off and replaced with a new one which has different terms. In the transaction, several things about your loan could change including your interest rate, the length of your loan, the loan balance itself and even the type of loan you have.
In a refinance, a payoff check is issued by the lender handling your new loan to the originator of your current loan. When that happens, your relationship with the old lender ends and your new lender takes over from that point forward.
When you’re refinancing, the loans break down into two categories. We’ll get into these in more detail later, but for now here are the basics.
- Rate/Term Refinance – If you’re looking to lower your rate or payment or even change your term without changing your existing mortgage balance, this is the mortgage option for you.
- Cash-out Refinance – If you want to convert the existing equity in your house into cash in order to make home improvements or boost a college or retirement fund, you can take out money with a cash-out refinance. This is also commonly used to consolidate high-interest debt like credit card balances because mortgage rates are typically some of the lowest loan rates you’ll see.
Options for Refinancing with Low Equity
Most loan options will require you to have a certain amount of equity in the home in order to refinance, but if you have very little equity or even owe more than your home is worth, you may have other certain options.
In this situation, the thing you can do most often is a streamline. That means the investor in your mortgage (e.g., Freddie Mac, FHA, VA, etc.) stays the same, but you may be able to lower your rate or change your term. Talk to your Home Loan Expert about any possible mortgage options you may have.
Why Should I Refinance?
There are many benefits and reasons why you might consider refinancing your mortgage. Here are the most common reasons people decide to refinance:
Lower Your Payment – A refi can be an opportunity to give your finances some breathing room. You can refinance your loan so that it has a lower monthly payment. And that extra cash can go toward your other financial goals, such as saving for a car, putting money into a retirement account or whatever other objectives you may have.
Lower Your Rate – Your interest payments make up a large portion of your monthly payment, especially in the first ten years. The higher your interest rate, the larger your monthly payment and the more you’ll pay over the life of the loan. When you refinance your mortgage to a lower interest rate, you’ll pay less in interest. When rates drop below your current rate, it may be a great time for you to swoop in and get a lower one. It’s always good to keep track of interest rates so you know when you can save the most money!
Change Your Loan Type – Sometimes we need a change of pace in life. If you’re interested in getting out of your fixed-rate loan, you may be the perfect candidate for an adjustable rate mortgage (ARM), which provides a lower interest rate than a fixed loan. After a period of time, though, this rate adjusts based on market conditions. Converting between adjustable and fixed can be a great way for you to save money while taking advantage of the lower rate during the fixed period. On the other hand, switching to a fixed rate gives you certainty.
Get Rid of Mortgage Insurance – If you have an increase in property value based on a new appraisal, you might refinance in order to remove private mortgage insurance (PMI). Meanwhile, once you reach 20% equity, converting from an FHA loan to a conventional one could help you ditch FHA mortgage insurance payments.
Cash for Repairs and Home Improvements – If the hot water heater went after years of service and the roof needs replacing soon, taking cash out of your home can make more sense than putting these bills on a credit card with a much higher interest rate.
Give Your Savings a Boost – Things like a child going to college or retirement age can sometimes sneak up on us faster than we know. If you find yourself behind the eight ball from a savings standpoint, a cash-out refinance can be a good low-interest way to give your accounts a much-needed infusion of green.
Consolidate Debt – If you have additional debt that has a high interest rate and you have enough equity in your home, you could consolidate that debt into your home loan and pay interest at a much lower rate.
Knowing what you’re trying to accomplish with a mortgage refinance will help you understand if it’s the right option for you.
What Should I Consider Before Refinancing?
Before you’re ready to refinance, there are several things you need to think about, including the following:
- Current Equity – Home equity is the amount of your home’s value that you own. You’ll need 20% equity to remove your PMI through refinancing. If you’re interested in refinancing for a different reason, your situation will depend on specific loan programs. Reach out to a Home Loan Expert to discuss your options.
- Credit Score – Much like buying a home, you’ll need to consider your credit score when refinancing a mortgage. You’ll need a credit score of at least 620 (or 580 in the case of an FHA loan) in order to refi your home.
- Length of Time in the Home – Not only do you need to wait a certain amount of time before you can take cash out if you just took over the title, but you also need to consider how long you want to stay in your home and whether refinancing will make sense. For example, do you really need to pay more for 15 years of rate certainty if you only plan on staying in the home for five years? An adjustable rate mortgage (ARM) is a loan with a 30-year term with a low teaser rate that stays fixed for a period of time – typically five, seven or 10 years – before it adjusts up or down, depending on what the market is doing. If you only plan on being in the home for 10 years, you would be able to get a lower rate with an ARM then you could with a fixed-rate mortgage and be ready to move before it ever adjusts. If you plan to own your home for two years or less, it’s likely not worth refinancing unless you refinance to a much lower rate.
- Other Outstanding Debt – A mortgage lender will have to take a look at your debt-to-income (DTI) ratio. The less income you have going toward debt, the better your chances will be to qualify. You can also look at taking equity out of your home for debt consolidation.
- Closing Costs – Closing costs on a refinance will typically be a bit cheaper than they are on a purchase, but they can still be significant. When talking to lenders about loan options, don’t overlook this. You may see lenders make reference to no-cost refinances. Know that there is no such thing. While you can often get a refinance with little to no closing costs, there’s a drawback. The lender will either charge a higher interest rate or roll the closing costs into the loan amount. For some people, it still makes sense to refinance this way and every situation is different. Just be aware that to get the lowest rates, you’ll typically have to pay higher closing costs. Be sure to speak with your Home Loan expert about all options.
- Mortgage Prepayment Penalties – Some lenders charge a penalty if you pay off your mortgage before a certain point in the term, say within five years of getting it. If you plan on refinancing, look at the terms of your current mortgage and see whether you’ll have to pay a penalty, because they should be factored into your decision as to whether a refinance makes financial sense.
- Loan Term – While there are exceptions if a financial change has made you want to drastically lower your payment, most people like to have a loan term that’s at least equal to the number of years they have remaining on their original mortgage if they can afford it. While many lenders only offer loans in set terms, Quicken Loans® is able to offer fixed-rate financing for conventional loans in terms anywhere between 8 – 30 years.
When you’re getting ready to refinance, the monthly payment shouldn’t be the only consideration. Make sure you’re also factoring in your goals, the loan’s term, your interest rate and closing cost. Not sure where to start? Our mortgage refinance checklist can help.
How Much Money Will I Save by Refinancing?
The most common reason to refinance is to save money. Naturally, one of the most common questions then is how much you’ll save by refinancing.
Every situation is different, but let’s run through a couple of scenarios just so you have things to think about. You can put in your own numbers with our refinance calculator.
Let’s say you wanted to pay off your mortgage faster and had $200,000 left on a home worth $250,000. You have 20 years left on your term and want to pay off your home faster. You have excellent credit.
You could refinance into a 15-year conventional fixed mortgage at an interest rate of 3.75% (4.227% APR) and have a monthly payment of $1,454.45. There are $7,057 in closing costs. However, by paying those closing costs and getting that rate you save more than $40,000 in interest.1
On the other hand, if you were to lengthen your term to lower your payment, you would save every month, but you would end up paying more in interest. It doesn’t work this way in the real world, but let’s keep everything the same except the term. If you had a 3.75% interest rate on a $200,000 loan, because the term is longer, you pay about $30,000 more in interest. In reality, this number is higher because a longer-term loan also means a higher interest rate.
What Are the Costs of Refinancing?
When you set up a mortgage, there are various associated costs you have to think about. Among the costs you can expect to pay are origination fees. These vary from lender to lender and depend on the type of loan you get. Other costs include:
- Appraisal fees
- Mortgage discount points
- Prepaid tax
- Insurance payments (combined with prepaid taxes to set up an escrow account)
- Any title insurance changes that may be necessary
- Loan origination fee
- Any upfront fees or payments for mortgage insurance if you have it
When Can I Refinance?
Before you can refinance, there’s sometimes a waiting period and lenders will say that your mortgage has to be “seasoned” for a certain amount of time. Seasoning simply refers to the age of your mortgage. Age requirements most often apply in cash-out transactions, but it may also apply in other areas, such as when you can have your equity recalculated based on a new appraisal.
In the following sections, we’ll go over how your options to refinance are impacted by how long you’ve had your current loan.
If you’re looking to take cash out, you have to be on the title of the property for at least six months if you have a conventional, jumbo or VA loan. If you have an FHA loan, the waiting period on a cash-out refi is one year.
On a rate/term refinance (taking no cash out of your equity), there’s no waiting period.
If you recently moved back into your former investment property, the FHA also requires you to prove you’ve lived there for at least a year. If you haven’t been back for at least a year, you can only do a rate/term refinance, and the maximum loan-to-value ratio (LTV) is 85%. In the case of a refinance, LTV is the ratio of the loan amount compared to the appraised value.
One thing to note is that if you inherited the property, there’s no waiting period necessary unless you had an FHA loan and rented the property out at any time since you inherited it.
Using a New Appraisal
If you’re looking to use a new appraisal to prove an increase in your equity that’s based on increased property value, there are special waiting periods involved depending on the type of loan you have.
If you have an FHA, a jumbo or a VA loan and you want a new appraisal to determine a value increase, you have to own the property a year before requesting the appraisal.
On agency loans from Fannie Mae or Freddie Mac, there is no specific timeframe you have to wait. The appraisal just has to be supported by changing market conditions and/or documented improvements made to the property.
Factoring in the Costs
Once you know what the costs are, it’s a matter of just doing the math. If you’re doing a rate-term refinance with the goal of lowering your payment, simply divide your cost to close the loan by the amount you’re going to save every month.
This will tell you the amount of time to stay in the house in order to break even on the deal. If you see yourself moving before you reach breakeven, refinancing may not be a great option.
As an example, if refinancing lowers your interest rate and saves you $50 per month on your payment, but it has $5,000 in closing costs, you would need to stay in the home 100 months – a little over eight years – to break even. If you were to move out before that point, refinancing isn’t right for you under the terms of that deal. It’s a matter of balancing the cost against both your plans for the refinance and your long-term goals.
Before you break out the slide rule, though, we can help you with this math problem. With Rocket Mortgage®, you can compare a customized mortgage solution with your current mortgage loan in order to quickly and easily see if refinancing makes sense for you. You can also speak with one of our Home Loan Experts at (888) 980-6716. If you’re a current Quicken Loans client, you can call (888) 980-4576 and we would be happy to compare any options to your existing mortgage with us.
We also always encourage you to take the opportunity to speak with a financial advisor before making any big moves affecting your future monetary planning.
If you want more information, view our refinancing options. If you still have questions, let us know in the comments below.
1 Calculations current as of 05/17/2019.
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