Over the past few months, you’ve probably seen more than your fair share of stories about refinancing your home mortgage. Why now? Mortgage rates are low—well below their historical average. Popular 30-year fixed rate mortgages are averaging about 3.75%. For many homeowners, now may be a good time to refinance your mortgage and capture that lower rate.
Why Refinance Your Mortgage?
Refinancing is not a simple edit to your existing mortgage. It’s a completely new mortgage that takes the place of your old one. You’ll get a new rate, new monthly payment, and, oftentimes, a new term. And it’s not for the faint of heart. There are a lot of steps, oodles of paperwork and associated costs in the thousands of dollars.
So why do people decide to refinance? Here are the four most common reasons:
- To take advantage of lower interest rates.
- To shorten their mortgage term.
- To convert from an adjustable-rate mortgage to a fixed-rate mortgage.
- To access equity (i.e., pull out some cash value) from their home.
Interest rates are so low right now that the Mortgage Bankers Association (MBA) reports that applications to refinance a mortgage were 104% higher in September 2019 than they were a year ago. If you’ve been considering a refinance, there are some important factors to consider before you jump right in.
Checking The Score
“From a lender’s perspective, the perfect refinance candidate has their proverbial financial house in order,” says Cheryl Young, senior economist at Zillow. “They have high credit scores, at least 20% equity in their home, and little other outstanding debt.”
Your credit score is probably the biggest factor in whether or not your application to refinance is approved, says Keith Gumbinger, vice president of HSH.com, a mortgage-resource website. The good news is that if your credit score has dramatically improved since you closed on your original loan, you may have the opportunity to get a much better interest rate through refinancing.
In order to qualify for the very best rates, you need a score above 740. It’s not unusual for scores to be dragged down by faulty information on your credit report, so before you even apply to refinance your mortgage, pull your credit report from all three credit bureaus, suggests Greg McBride, chief financial analyst at Bankrate.com. “You’re entitled to a free credit report [from each bureau, Equifax, Experian and TransUnion] every 12 months. This way, you can make sure your report is correct and you can fix any errors before moving forward.”
Investigating The Cost
Refinancing your mortgage isn’t cheap. You have to pay for many of the same things you’d be responsible for if you were taking out a brand-new mortgage (which, in fact, you are), including closing costs an application fee, an appraisal and a title search. “To find out what you can realistically expect to spend on your refinance, pull out your old mortgage documents,” Gumbinger suggests. “These are the actual fees you paid for the property you are refinancing, and they should give you a solid basis for what costs should be.” Gumbinger suggests budgeting about 2-3% for closing costs. For example, for a $200,000 mortgage, be prepared to pay roughly $4,000 to $6,000.
How do you know if it’s worth it? Run the numbers. Take the costs involved in closing your loan and divide by the monthly savings. “If it costs you $3,000 to refinance and you save $100 a month, it will take you two-and-a-half years to recoup your spend,” McBride says. A typical or “good” break-even period is around two to three years. If you do the math and yours is any longer than that, McBride suggests shopping around for a better rate.
Do Your Research
Young, Gumbinger and McBride all stress the importance of shopping around for the very best rate. Including your current lender in your search is a good idea; they already have all of your information and may be willing to work with you in order to keep your business. McBride suggests researching lenders and requesting quotes from a few so you can compare and contrast.
Remember, each lender has an application fee, which can run between $350 and $500, so don’t apply until you’re ready to pull the trigger. “You could run through a bunch of cash by applying all over town,” Gumbinger says. He suggests diligently shopping around, and actually applying to as few as possible.
Refinancing is a big decision that shouldn’t be taken lightly. But the benefits can save you, quite literally, thousands of dollars. While the process might seem daunting, think about it this way: It’s another great reason to get your financial house in order. Pulling together all these documents will mean you have a crystal clear picture of where you stand financially, and if everything works out, you could find yourself enjoying a lower mortgage payment for years to come. Good luck!
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