MoneyMix Contributor
If you've ever considered refinancing your home loan, now might be the time as historically low rates persist. While refinancing might not be for everyone, you could save thousands of dollars over the life of your loan if you qualify.
refinance to save
Homeowners refinance for a number of reasons: to get a lower rate, adjust the length of the loan, consolidate debt, or convert an adjustable-rate mortgage (ARM) to a fixed rate, says Tracy Ashfield, owner and president of real estate consulting firm Ashfield & Associates, Madison, Wis.
"For most people, a mortgage is the largest debt they have and it comes down to evaluating the best way to manage their debt," Ashfield says. "You're always trying to streamline and get overall debt on your home to be the most economical and efficient to control."
By locking in a better rate on your loan, you can reduce your monthly payment and save thousands of dollars in interest over the life of your mortgage. A lower interest rate also can allow you to build equity in your home more quickly.
Ashfield recommends getting an original rate quote in writing to lock it in. She also notes that advertised fixed rates are the lowest starting points. Depending on the equity in your house, your credit score, and the kind of property you're refinancing, the rate could go up.
"You always want to evaluate. Research to find out what your rate would be for your particular situation," Ashfield says. "Many people are saving a lot with refinances, but the bottom line here is to assess your situation. If you have questions, talk to [the professionals at] your credit union."
Credit unions have the lowest fees, competitive rates, and offer the greatest flexibility. In addition to landing a lower rate, you might choose to rework the length of your loan. By choosing a shorter term—say, a 15- or 20-year loan instead of a 30-year—you'll generally have higher monthly payments but will retire your mortgage sooner. Lower-term loans typically carry lower interest rates.
Here are examples of monthly savings potential by refinancing to a lower-interest-rate loan and from refinancing to a shorter-term loan.
steps to refinance
Begin by getting a copy of your credit report. Go to AnnualCreditReport.com to request your free report, up to three times a year. Check your report for accuracy, and report any questions or errors to the credit reporting agency.
If you're working with a lender he or she may be willing to share your credit score with you. Your free report does not contain your credit score, but you can purchase your score from MyFICO.com for $19.95. Be aware—the site also advertises a free FICO score which is packaged with a credit watch service for $14.95. (You may cancel your membership anytime within the 10-day trial period without charge.) A credit score of 740 or higher is considered very good. If your credit score is low or on the bubble, consider paying off credit cards and paying down other debt or loans to boost it.
When you refinance, you close your existing mortgage and create a new one. The approval process to refinance is similar to the process to obtain your original loan. Your lender will consider your income and debt, credit score, and other factors affecting your financial situation. Many lenders believe a person's housing debt should not exceed a quarter of his or her gross monthly income. Further, a consumer with a total debt-to-loan ratio approaching 50% often will encounter difficulties obtaining a mortgage.
HARP helps more homeowners refinance
Historically, homeowners with negative equity in their homes have not qualified for refinancing. Now, changes under the government's Home Affordable Refinance Program (HARP) have expanded the guidelines. Homeowners with loans backed by Fannie Mae or Freddie Mac and who are current on their mortgage may be eligible, even if the home value has declined. For more information about the HARP changes, visit Making Home Affordable.
Your new interest rate will be based primarily on your down payment and credit score. Historically, credit unions have the lowest fees and competitive rates and offer the greatest flexibility. Shop around to find the best fit for your financial situation, Ashfield recommends.
When considering a refinance, you also want to understand your break-even point: Weigh the costs of refinancing against how much you'll save each month to know when you will recoup your costs. Talk to your credit union loan officer to evaluate your financial situation and assess the benefits of refinancing.
Ashfield suggests keeping a close eye on interest rates, and points out that many credit unions have online mortgage calculators or apps that can help. These calculators usually require information about your current mortgage, the new loan you're considering, and the upfront or closing costs that you'll pay for the loan.
Once approved, your loan officer can help you through the steps, including costs for application, loan origination, appraisal, inspection, attorney review, title search, title insurance, and prepayment penalty fees. Fees and costs vary by state.
While some lenders package mortgage refinancing to appear to be no-cost, these types of loans typically just avoid upfront fees—you still will pay in the end. No-cost financing generally carries a higher interest rate to cover closing costs or rolls costs into the new loan balance and monthly mortgage payments. Ask for a comparison of the costs, principal, rate, and payments—with and without the no-cost financing.
when refinancing may not be better
According to "A Consumer's Guide to Mortgage Refinancing" from the Federal Reserve, there are a few instances when refinancing might not be a good idea:
- Your mortgage is mature—As you pay off your mortgage, more of each payment applies to principal and less to interest. This helps build equity. By refinancing, you'll restart the amortization process and more of each payment again will go toward interest. You can calculate your payments using a refinance calculator to determine if refinancing is the right solution.
- You have to pay a prepayment penalty—While this is not common, lenders might charge a fee for paying off your mortgage early—including for refinancing. Consider this when calculating your break-even point.
- You plan to move soon—If you plan to move in the next few years, the monthly savings may not outweigh the costs of refinancing in so short a time.
The decision to refinance your mortgage should reflect the best way to manage your debt. Your credit union lender can help you evaluate your financial situation and discuss your best options.
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