Rates Are Dropping, But Should You Refinance?
As mortgage interest rates approach record-lows, many U.S. homeowners consider the benefits of refinancing.
With today’s 30-year rates hovering in the 3s, and 15-year fixed rates in the 2s, it’s easy to see why.
According to Freddie Mac, the 30-year fixed rate averaged just 3.48% as July came to a close. Compare this to one year ago when the agency reported a 4.09% average.
This drop alone means a homeowner will save an additional one hundred dollars per month on a $300,000 mortgage, compared to a year ago.
But ultra-low rates don’t mean a homeowner should automatically refinance.
Monthly savings is one factor, but the refinancing borrower should also look at the cost of the refinance, their current home equity position, and other details.
With rates this low, homeowners may find out that all signs point toward taking next steps toward a lower rate.
What Is A Refinance?
A refinance is a new loan that replaces an existing one, typically at a better rate or more advantageous terms.
Homeowners can customize their refinance by choosing their combination of rate and fees, the loan length, and the amount borrowed.
Since you’re applying for a brand new mortgage loan, lenders will typically need to obtain the same information and documentation they needed when you bought your home.
But there are many exceptions to the rule.
The FHA streamline refinance does not require re-certification of income. Nor does it require an appraisal. Lenders do not ask about current value, even if home values have dropped.
Likewise, the HARP loan often comes with an appraisal waiver. Current home value is nearly irrelevant for this loan.
The VA IRRRL (Interest Rate Reduction Refinancing Loan) is perhaps the best example of a low-documentation refinance. It requires no income verification, no bank statements, no appraisal, and no credit report — at least that’s what VA rules state.
Most lenders will require a credit report to ensure the borrower meets the the mortgage provider’s own minimum FICO score, but the VA itself doesn’t require it.
For a standard conventional refinance, lenders verify key information such as employment and income, credit scores and payment history, and appraised value.
Benefits Of Refinancing
Homeowners refinance for a variety of reasons, but for most of them, it’s to get a better interest rate and lower payment.
Lowering an interest rate by just 1% can have a substantial effect on a homeowner’s monthly payment.
For example, a homeowner purchased a home four years ago and financed $250,000 at 4.5 percent.
Her balance after four years is about $232,000. She can save two hundred dollars per month by refinancing into a new rate of 3.5 percent.
If money is tight, a savings of more than $200 per month could have a profound impact on a family’s budget.
Other reasons to refinance are as follows.
- Convert an adjustable-rate mortgage (ARM) to a fixed-rate
- Withdraw home equity as cash
- Cancel mortgage insurance
- Convert a 30-year loan to a 20- or 15-year
Sometimes homeowners refinance even though their rate or payment goes up. It all depends on the benefits of the refinance.
Factors To Consider Before Refinancing
Low mortgage rates are a great reason to consider refinancing. However, homeowners may want to factor in other considerations.
1. Your current interest rate
Generally, if you can lower your mortgage rate and payment, it may be worth refinancing.
Some experts state you should drop your rate by at least 1% if you refinance. That’s not always true, however.
A homeowner with a large balance can reduce monthly costs dramatically by dropping their rate by just 0.25%.
For example, a homeowner in Queens, New York might have a loan at the Fannie Mae loan limit of $625,500. A one-quarter percent drop in interest rate will save $100 per month.
Someone with a very small loan balance, however, may need to reduce their rate by 2-3% before they see enough savings to justify a refinance.
2. The refinance cost
Closing costs should always be taken into consideration when it comes to refinancing.
If you can save $100 per month but it costs you $5000 to do so, that means the recoup time would be 50 months. Unless you are going to be in your home for more than four years, it may not make sense to refinance.
Alternatively, if it costs you $3000 for closing fees but you’re saving $200 per month, you’d recoup the costs in just 15 months.
There are some refinance programs that offer “no cost refinancing.” This describes a loan for which the lender issues a slightly higher interest rate in exchange for reduced — or eliminated — closing costs.
This option puts the recoup time at zero. In other words, there is little reason not to refinance.
3. Effects of paying your loan longer
Homeowners who have paid their loan for a number of years should look at how long they are extending their loan term.
For instance, if you have been paying your loan four years, you likely have 26 years left. If you refinance, that jumps back to thirty years.
Here’s how to determine whether the extended loan term is worth it. This scenario is based on the following assumptions.
- Original mortgage: $250,000
- Rate: 4.5%
- Year loan started: 2012
- Year to be paid off: 2042
Under these terms, the loan would be retired twenty-six years from now, for a total principal and interest cost of $456,000.
The following describes the terms of the new refinance loan, assuming a portion of the principal balance paid off, and closing costs wrapped into the new loan amount.
- Refinance loan amount: $236,000
- Rate: 3.5%
- Year loan started: 2016
- Year to be paid off: 2046
The total principal and interest cost over thirty years is $381,000. Add in the cost of the first four years of the previous loan, which is sixty-one thousand dollars. The total cost is $442,000, or fourteen thousand dollars less than if the applicant would have kept the original loan.
In this case, a refinance still saves money, even though the loan repayment period extends.
But this calculation doesn’t factor in making extra payments.
The above scenario would reduce the homeowner’s payment by $200 per month.
The homeowner could voluntarily re-invest the monthly savings back into the payment. In short, the applicant refinances, but continues to make the identical payment as before.
With this option, the homeowner owns the house free-and-clear after twenty-two years and saves an additional forty thousand dollars in interest.
This is just one scenario, but the idea can be applied to any situation. Make sure the refinance accomplishes short- and long-term goals and makes financial sense for you.
4. Your home equity
With the exception of a few loan programs, lenders will verify that you have at least a small amount of equity in order to refinance.
Generally, the more equity you have in your home, the easier it is to refinance. However, don’t let a lack of equity keep you from applying.
Even if you have little equity, or perhaps you’re even underwater on your mortgage, you may still be able to take advantage of today’s historically low interest rates.
Loan programs such as the FHA Streamline refinance, the VA IRRL and the HARP program allow homeowners to refinance with no equity.
A refinance applicant currently holding one of the following loan types may be eligible for a refinance despite their equity position.
- FHA mortgage
- VA loan
- USDA home loan
- Fannie Mae mortgage
- Freddie Mac mortgage
You may have one of these loan types even if you make your payment to a banking institution or mortgage servicer, such as Wells Fargo, US Bank, Chase, Green Tree Servicing, Ocwen, or PNC.
Check your loan statement or contact a lender to check your current loan type.
What Are Today’s Refinance Rates?
Compared to a year ago, today’s mortgage rates are down over half a point, resulting in new opportunities for U.S. homeowners.
Get today’s live mortgage rates now. Your social security number isn’t required to get started and all quotes come with access to live mortgage credit scores.