Interest rates have plunged since the start of the pandemic, and—although they’ve begun creeping up in recent weeks—remain at historically low levels.
So BILLSHARK wanted to give you some insights on what to consider before you refinance your home mortgage. Refinancing, by the way, means getting a new mortgage loan with better terms than you have on your current mortgage.
First let’s look at the reasons you might want to refinance. There’s no doubt that refinancing a mortgage can be onerous and time consuming. You have to go through the shopping and loan application and approval process all over again. But there are also good reasons to do so.
1. Lower monthly payments
The best reason to refinance is to receive a lower monthly payment on your mortgage. This then frees up extra cash for other needs. If your current interest rate is 1-2 percent higher than the rates being offered today, it can definitely make sense to look for a lower interest rate. (See the caveat about advertised rates, below.)
2. Switch from an ARM to a fixed-rate mortgage
If you took out an adjustable-rate mortgage (ARM) when you bought your house, now is the time to think about switching to a fixed-rate mortgage.
3. Drop PMI
If you bought your home with less than 20 percent as a downpayment, you no doubt were also forced to buy private mortgage insurance (PMI) in case you defaulted on your loan. If you can get rid of it, it could save you as much as $100 a month on your payment or more. This depends on the size of your loan.
While some lenders automatically drop PMI when your loan-to-value (LTV) ratio reaches 20 percent (that is, the house is now worth 20 percent more than you paid for it), often you have to refinance your loan to get rid of PMI.
4. Get cash
While we do not recommend a cash-out refinance, you may be in a situation where you need to get your hands on the equity in your home. Making home improvements or starting a new business are frequent reasons people take out the cash equity in their homes when refinancing.
This can be dangerous, however, because your equity value is now zero. And if home prices drop in the future (as we saw during the Great Recession), you could end up owing more on your loan than the house is worth. This is commonly known as being “underwater.”
Why not to refinance your mortgage
On the other hand, there are times when you shouldn’t refinance your mortgage.
1. When you won’t save money
In the current environment, it’s fine to at least shop around to see what types of terms lenders can offer. But if the difference between your old interest rate and your new one isn’t significant, you could end up paying more in fees and closing costs than you’ll end up saving. These fees and costs average between 2-5 percent of the loan.
And while it’s often possible to roll the costs of refinancing into a new home loan, such costs can end up wiping out any savings you may have achieved by refinancing. Don’t forget, you’ll now be paying interest on those closing costs, which doesn’t make good financial sense in the long run.
2. You’ll be moving soon
If you don’t plan to live in the home for at least five more years, it’ll likely cost you more in refinancing costs than you’d recoup from rising home values in your area.
3. You have less-than-stellar credit
You simply cannot get the best interest rates unless your credit is in excellent shape. Lenders have too many people falling over themselves to originate new mortgages or refinance existing ones. Most saw their normal volume of loan applications jump by 400 percent in recent months. Therefore, they can afford to be choosy and not feel they have to compete for your business.
According to Ellie Mae’s Origination Insight Report, nearly three-quarters of all the refinances that closed this past September involved borrowers whose FICO score was 750 or higher.
Which brings us to the caveat we mentioned above. Lenders may advertise a certain low rate, but raise it when you sit down to talk.
“Lenders are having a hard time keeping up with the volume of applications from homeowners and purchasers, so some have raised rates a little to maximize their profits while reducing their volume,” Patrick Boyaggi, CEO of Boston-based mortgage technology company OwnUp, told The Washington Post.
So . . . refinance or forget it?
Considering what we’ve told you here, it might be worth your while to least look around. And that means investigating more than one lender.
“Your [mortgage interest] rate . . . depends a lot on the lender you choose, because different lenders have a different appetite for risk,” said Boyaggi. “Your mortgage rate can vary by as much as 0.5 percent or one percent for the same loan from different lenders.”
Could use a little help with some extra cash? Let BILLSHARK’s professional negotiators take a look at your bills? Our review is free. We charge only if we can save you money!