Interest rates remain near historic lows, but refinancing your mortgage isn’t always the right move. Here’s what to weigh before you trade in your current home loan for a new one.
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.
1 Why Refinance Your 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.”
2 When You Shouldn’t Refinance
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.
3 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.”
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Frequently Asked Questions
What does it mean to refinance a mortgage?
Refinancing means getting a new mortgage loan with better terms than you have on your current mortgage. You go through the shopping, loan application, and approval process all over again, which can be onerous and time consuming, but it can pay off if the new terms lower your monthly payment or otherwise improve your situation.
When is refinancing your home mortgage a good idea?
Good reasons to refinance include lowering your monthly payment, switching from an adjustable-rate mortgage (ARM) to a fixed-rate loan, dropping private mortgage insurance (PMI), or pulling out cash equity. Lowering your payment makes the most sense when your current interest rate is roughly 1-2 percent higher than the rates being offered today.
How can refinancing help me drop PMI?
If you bought your home with less than 20 percent down, you were likely forced to buy private mortgage insurance (PMI). Getting rid of it could save you $100 a month or more, depending on your loan size. While some lenders drop PMI automatically once your loan-to-value ratio hits 20 percent, often you have to refinance your loan to get rid of it.
When should you not refinance your mortgage?
Avoid refinancing when you won’t actually save money, since fees and closing costs average 2-5 percent of the loan and can wipe out your savings. Also skip it if you plan to move within five years, or if your credit is less than stellar, because you can’t get the best rates unless your credit is in excellent shape.
Why do refinance rates vary so much between lenders?
Lenders may advertise a low rate but raise it when you sit down to talk, partly because high application volume lets them maximize profits while reducing volume. According to OwnUp CEO Patrick Boyaggi, your mortgage rate can vary by as much as 0.5 percent or one percent for the same loan from different lenders, so it pays to investigate more than one.
