Posted by Pat Raskob

When Should I Refinance My Mortgage?

When Should I Refinance My Mortgage?

Perhaps you are considering if it is time to refinance your mortgage; if that is the case, then you need to know how much you can save and how much it will cost to refinance.

Ideally, refinancing should save you money in both short and long term, lowering your monthly payments and lowering your interest rate. But you'll need to make sure that your savings are large enough that you don't lose money after handling the closing costs to refinance your mortgage.


What is mortgage refinancing?

A mortgage refinances the replacement of the existing mortgage with a new mortgage with different terms. Normally, one of those terms is a lower interest rate. Sometimes it takes a different number of years to pay off. It is rarely a fixed rate rather than an adjustable rate or vice versa.

It can also be another type of loan, such as a conventional mortgage rather than a Federal Housing Administration (FHA) mortgage. In all cases, the goal is for the new mortgage to be more advantageous to you, with lower monthly payments, than the current mortgage.


When is the right time to refinance my mortgage?

Homeowners refinanced 2.6 trillion in debt last year due to historically low mortgage rates. Rates are still extremely low, so it's worth working out the numbers and seeing how much you can save by refinancing now. Here are some signs that the timing may be right.


• You can reduce the rates by at least 0.5%: No rule of thumb determines which lower interest rate makes refinancing worthwhile. You need to calculate how much you would save based on each lender's offer. But if your current rates are lower than they are now, now is a good time to do the math and examine your options. The typical homeowner who refinanced in 2020 cut the rate by 1.2 percentage points. Borrowers with very good to excellent loans receive the best rates.


• You can pay off your mortgage faster: Refinancing a shorter-term mortgage can save you more money by consolidating a lower interest rate with some years of payments.

For example, if you borrowed $300,000 and the interest rate on a 30-year mortgage was 3.5%, your monthly pay is $1,350, and you would pay $185,000 in interest on the mortgage—a period of 30 years.

If you refinance this amount into a 2.1% loan over 15 years, your new monthly payment will be $1,900, and you will pay $49,000 in interest over the next 15 years (plus the approximately $10,000 in interest that you pay during the first year of your 30 years mortgage). You will save $126,000 in the long run, minus the closing cost of about $3,000.

The idea is that you can easily pay the higher monthly payment for the shorter mortgage, in this example, an additional $550 per month for 180 months.


• You want another type of mortgage: If you have an adjustable-rate mortgage but prefer to lock in a fixed rate, this is a good reason to refinance. If you initially took out an FHA loan because your loan wasn't good, but your score is now much higher, you may want to refinance a conventional loan to stop paying FHA mortgage insurance premiums.


• You wish to withdraw part of the capital: In June, according to Zillow, home values rose 15% from the previous year. If you're looking for money to repair your home, renovate, or pay off high-interest debt, cash-out refinancing might be a good idea if you can lower your mortgage rate.


Is refinancing a bad idea? If so, when?

It's tempting to consider refinancing when you see how low the current market rates are and how many others are doing it. However, after considering your situation, refinancing may not be a good option for you if any of these situations occur.


• It will greatly extend the life of the loan: Suppose you are five years old with a 30-year mortgage. If you refinance with another 30-year loan, you end up in a situation where you pay off a 35-year mortgage. Because you pay interest mostly in the first few years of a 30-year loan, this type of refinancing can be high-priced in the long run, even if it reduces your monthly payment in the short run.


• When the payment term is too long, you must calculate the break-even point if refinancing for a shorter period is not an option. Divide the monthly savings by the closing costs to see how long it will take you to continue refinancing. For instance, if you paid $3,000 to refinance a new 30-year mortgage that saves you $200 per month, it would take 15 months to balance. If you plan to sell your home in a year, you will be wasting money on refinancing.


• You don't have a good plan on how you will use your money: Just because you can do a cash-out refinance doesn't imply you should. If your goal is to be mortgage-free and refinancing your retirement won't significantly improve your finances or quality of life, you can ignore it.


• Out of work: Most of the time, you won't be able to refinance if you are unemployed. If you have a VA or FHA loan, you may be eligible for streamlined refinance. If you are having difficulty making conventional loan repayments, you may be eligible for a loan modification. However, without a substantial source of income, you probably won't be able to refinance your conventional loan.


How am I going to refinance my mortgage?

Refinancing will likely be easy for you, as this is not your first time applying for a mortgage. You already know how the process will play out.

However, you don't need to stick with your current lender. You can and should compare prices and get at least three quotes. It makes sense to choose the option that saves you the most.

Also, something different from the last time you applied for a mortgage is that many lenders have made more changes to their online processes. You can avoid paper documents by uploading the information requested by the creditor through a secure online portal. You can sign your closing documents online and file them with a remote notary, depending on where you live and how the lender operates.


What to expect from refinancing

After submitting your application, you will need to provide the creditor with documents such as recent bank statements, tax returns, W-2 forms, and payment receipts showing that you will repay the new loan.

 

The interest rate

At some point in the refinancing process, it will be necessary to freeze the interest rate. Your lender is supposed to tell you how long you can expect your loan to end based on your current business terms.

You want to make sure that your fixed-rate lasts long enough to complete the closing. You will probably want to freeze your rate early in the application process to eliminate the risk of a rate increase affecting your refinancing decision.


Additional charges

Refinancing typically costs less than 1.3% of the loan amount when taxes are included. The average closing cost of a single-family home refinance is $3,398, taxes included in 2020.

Here are the expenses you can expect to make when you refinance:

  • Credit report fees

  • Creditor title search and title insurance costs

  • Escrow/closing service charge

  • Land survey (sometimes)

  • Loan issuance costs

  • Notary fees

  • Pest inspection fees

  • Rate reduction points (optional)

  • Residential assessment commission

  • Subscription fees

  • Tax on real estate transfers (if applicable in your jurisdiction)

If the numbers are working in your favor, refinancing can be a great way to save money. While the process can have administrative headaches, in the end, the wait (and the work) is usually worth it.


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Pat Raskob
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