Should I Refinance The Mortgage On My House And Is Now The Right Time?
*As of April 20, 2020, Quicken Loans® isn’t offering conventional adjustable-rate mortgages (ARMs).
If you’ve been paying attention to interest rates over the past couple of years, you know that they are at historic lows. If you’re thinking about refinancing, that makes this a good time to decide whether you should move ahead with a refi.
Refinancing your mortgage can be a great, money-saving option for many homeowners. A refi can provide the money you need for home renovations, a major purchase or an unforeseen need for cash. Or it may drastically reduce your monthly mortgage payment, especially if your credit score has improved, or you’re refinancing for a lower interest rate or longer term.
However, refis aren’t cheap. You’ll need to plan to pay closing costs that generally run between 3% and 6%.
With this in mind, let’s take a look at the factors you should consider when thinking about refinancing your mortgage.
What Is A Mortgage Refinance?
A mortgage refi essentially means that you are trading in your old mortgage for a new one. There are only small differences between applying for a mortgage and applying for a refi. You won’t need a new home inspection in most cases – though lender policies vary – but you’ll need to submit your financial information to your new lender just like you did for your old lender.
How Does Mortgage Refinancing Work?
When you refinance, your current loan gets paid off and replaced by a new one with 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.
When you’re refinancing, the loans break down into the following two categories. Which path you take depends on what you want to accomplish through the refinancing process.
If you’re interested in lowering your monthly payment by lowering your mortgage interest rate, or would like to increase or decrease your loan term without changing your existing mortgage balance – and without taking any cash back – a rate/term refinance might be the mortgage option for you.
If you want to convert the existing equity in your house into cash in order to make home improvements or to 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.
Factors To Consider Before Refinancing
Before you’re ready to refinance, there are several things you need to think about, including the following:
1. Your 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 have an FHA loan and at least 20% equity in your home, you might want to refinance to get rid of your mortgage insurance premiums. If you’re shy of that, you might want to wait until you cross that threshold before applying for a refinance.
2. Your 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 or VA loan) in order to refi your home.
3. Your DTI Ratio
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.
4. Length Of Time You Plan To Stay In Your 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 5 years?
An adjustable rate mortgage (ARM) offers a 30-year term with a low teaser rate that stays fixed for a period of time – typically 5, 7 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’ll be able to get a lower rate with an ARM than you could have gotten with a fixed-rate mortgage and be ready to move before it ever adjusts.
If you plan to own your home for 2 years or less, it’s likely not worth refinancing unless it’s to a much lower rate.
5. Your 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.
Many lenders only offer loans in set terms, but Quicken Loans is able to offer fixed-rate financing for conventional loans in terms anywhere between 8 – 29 years.
6. Closing Costs
Closing costs on a refinance will typically be a bit cheaper than they are on a new home 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-closing-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.
7. Mortgage Prepayment Penalties
Some lenders charge a prepayment penalty if you pay off your mortgage before a specified point in the loan term. If you plan on refinancing, look at the terms of your current mortgage and see if you’ll have to pay a penalty, because they should be factored into your decision as to whether a refinance makes financial sense.
Why Should I Refinance? The Benefits
There are many benefits of 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 you have a lower monthly payment going forward. The extra cash you’ll have on hand from lowering your payment 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 Interest Rate
Your interest payments make up a large portion of your monthly payment, especially in the first 10 years of your mortgage. 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 and APR, you’ll pay less in interest over the life of the loan. 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 you need a change of pace in life. If you’re interested in getting out of your fixed-rate loan, you may be interested in an adjustable-rate mortgage (ARM), which provides a lower interest rate than a fixed-rate 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 provides the certainty of always knowing how much your monthly mortgage payment will be, making budgeting much easier.
Get Rid Of Your 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).
It’s also very common to refinance FHA loans once borrowers reach a 20% equity threshold. FHA loans require MIPs even after you’ve reached an LTV of 80%, so to avoid continued MIP payments, you’ll need to refinance from an FHA loan to a conventional loan.
Access Cash For Your Repairs And Home Improvements
If the hot water heater broke and the roof needs replacing soon, taking cash out of your home with a refinance can make more sense than putting these bills on a credit card with a much higher interest rate.
Your home is likely your largest single asset and if you want to keep it appreciating in value, you’ll need to keep it in good repair and up-to-date. On the bright side, the money you spend on capital improvements will not only help you keep up with the real estate market. It will also be added to your cost basis in the home – typically the property’s purchase price – and could help you save on capital gains taxes when you sell.
Boost Your Savings
Major events like a child going to college or your reaching retirement age can sometimes sneak up on you. 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 Your 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.
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’ll save over $40,000 in interest.
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’ll 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 property tax
- Insurance payments (combined with prepaid taxes to set up an escrow account)
- Any title insurance changes that may be necessary
- Mortgage origination fee
- PMI, if you are not at the 20% of home equity, or MIP, if your refinance is through the FHA
When Can I Refinance?
Before you can refinance, there’s sometimes a waiting period, and some 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, like delayed financing loans, but they 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 6 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 1 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 home 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 in which 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 of refinancing 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 8 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.
The Bottom Line: Your Circumstances Determine The Right Time To Refinance
When you’re getting ready to refinance, make sure you’re factoring in your goals, your loan’s term, your interest rate and the overall costs associated with your decision as well as your monthly payment. Refinancing a mortgage loan can be an extremely useful option for many homeowners, but it’s important to take the time to properly assess whether a refinance is the best fit for your needs before fully committing to it.
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.