An increasing number of homeowners across the country who have existing mortgages are thinking about going the refinancing way. The main reason behind this move is that mortgage rates have continued to slide in recent weeks owing to the ongoing Covid-19 pandemic. People who are thinking about refinancing their existing mortgages may also benefit by shortening the term of their mortgages, changing the type of mortgage they have, or even tapping into the equity they’ve built over time.
The Interest Rate Scenario
Financial markets in the U.S. have shown some stability in the last fortnight when compared to prior weeks. It seems like mortgage rates have bottomed out, and look to be increasing again. Freddie Mac reports that the average 30-year fixed-rate mortgage was 3.33% on April 2. It stood at 3.29% on March 5. However, compared to a year ago, it’s down by 0.75%.
The 15-year fixed-rate mortgage averaged at 2.82% on April 2. This was a slight increase when compared to the 2.79% average on March 5. In comparison to a year ago, the average interest rate dropped by 0.74%.
Even the 5/1 adjustable-rate mortgage average has experienced an increase since March 5, going from 3.18% to 3.4%. Over the last 12 months, the average has dropped by 0.26%.
Bear in mind that these are not the interest rates you will get if you choose to refinance your existing mortgage. The interest rate you get depends on multiple factors such as the lender you select, your creditworthiness, the equity you’ve built in your house, and a steady source of income.
Is Now a Good Time to Refinance?
Given that interest rates have stopped their downward spiral for now, there is no telling just how long the low interest rate atmosphere might prevail. As a result, waiting for rates to fall even further might be foolhardy.
It might make sense to get your application out of the way, because a number of lenders already have to deal with overworked employees. While the increased demand has resulted in some lenders hiring more employees, other lenders are choosing to play wait and watch – unsure of what role the new employees would play when interest rates increase again.
The existing interest rate atmosphere might work as a blessing for some homeowners, even if there is no further drop in rates. Data released by Black Night, an integrated technology and data and analytics solutions company, suggests that more than 11 million American homeowners could save around $270 each month by refinancing their mortgages.
Is Refinancing Right For You?
If your existing mortgage attracts 4% or more as interest, and if your credit score is above 720, you might benefit by refinancing your mortgage. However, there are several aspects you need to consider because even seemingly good deals can result in losses at times.
The Time Factor
Time plays different roles when it comes to thinking about refinancing a mortgage. For starters, just how long you plan to maintain your loan has a bearing on whether or not you should refinance. If you don’t plan to live in the house in question for the next five years or more, refinancing might not be the best way forward. This is because any savings you incur could be offset by the fees you end up paying.
Homeowners who plan to live in their existing homes for the long-term might benefit by refinancing their mortgages. The savings can be even more pronounced if you switch from a 30-year mortgage to a 15-year mortgage. In such a scenario, you would need to pay a higher monthly repayment. However, you could also potentially save tens to hundreds of thousands of dollars form of interest over the life of your loan.
Consider this – you have a 30-year fixed-rate mortgage of $100,000 with an interest rate of 9%. If you get a 15-year mortgage with a 5.5% interest rate, your monthly repayment would experience a negligible increase, rising from around $805 to around $817. On the other hand, if your 30-year fixed-rate mortgage for the same amount comes with a 5.5% interest rate, and the new 15-year mortgage charges 3.5% as interest, your monthly repayment would increase from around $570 to around $715.
You may use an online calculator to see which time period works better for you when it comes to affordability of monthly repayments. What works in favor of a shorter loan term other than having to pay lesser interest is that you build equity faster. This enables you to apply for a reverse mortgage or a renovation loan with ease, if you ever need one.
How Much Will You Save?
The usual rule-of-thumb suggests that you should refinance a mortgage only if the new interest rate is at least 1% lower than your existing interest rate. However, that’s as traditional a thought as the one that suggests requiring at least 20% down payment to buy a house, whereas it is possible to buy a house even without making any down payment.
Refinancing a mortgage might lead to savings even if there’s a 0.5% drop in the interest rate. Interest rates may vary from one lender to the next, which is why you need to compare as many alternatives as possible. The fees that you need to pay to refinance your loan require your particular attention, because these might have a significant impact on the overall cost. Some lenders offer better rates to borrowers who pay more toward closing costs.
If you have a 30-year loan of $300,000 at 4.5% interest, you would be paying around $1,520 each month in principal and interest. The total repayment would be around $547,200. If the same loan attracts 3.5% as interest, the monthly repayment drops to around $1,345, and the total repayment falls to around $484,970. This results in savings of around $175 each month, and around $62,200 over the course of the loan.
The Fees You Need to Pay
Just how much you end up paying in the form of refinancing costs depends on the state in which you live as well as the specifics of your mortgage. Typically, the cost to refinance a home loan hovers in between 2% to 5% of the loan amount. The costs come in different forms, such as:
- Prepayment penalty. When you refinance your existing loan, you are basically repaying it ahead of time, and replacing it with a new one. Repaying your loan before its term comes to a close might require that you pay a prepayment penalty. The penalty you need to pay might be a fixed amount, a percentage of the outstanding loan amount, or based on how long you’ve had the mortgage.
- Application fees. Depending on the lender you select, you might need to pay an application fee of anywhere between $75 and $300. This fee is usually non-refundable, even if you don’t qualify for the loan.
- Loan origination fees. These fees cover the administrative costs that a lender bears when generating a new mortgage. It can vary from 1% to 1.5% of the loan amount.
- Appraisal fees. Your new lender might want to get your house appraised to determine its existing market value. The appraisal fee varies between $300 and $500.
- Title search and insurance. Lenders rely on title searches to verify your homeownership status, and to check if there are any judgments or liens against your property. The insurance is in place to safeguard the search’s validity. This would set you back by $400 to $900.
Are You Refinancing to Change the Type of Mortgage?
A number of homeowners are thinking about converting the type of interest rates their mortgages attract – from adjustable-rate mortgages (ARMs) to fixed-rate mortgages, and vice-versa.
With ARMs, the interest rate during the initial period is lower than that of fixed-rate mortgages. However, subsequent interest rates hikes through the course of the loan can get the interest rate to exceed that of fixed-rate mortgages. In such a scenario, converting an ARM to a fixed-rate mortgage can lead to a noticeably lower interest rate, resulting in sizeable long-term savings.
The converse holds true for people who don’t plan to stay in their homes for long and want to convert their fixed-rate mortgages to ARMs. In this case, you could benefit through the existing low-interest-rate atmosphere as well as lower monthly repayments.
If interest rates fall further, opting for ARMs might make more sense. This is because the periodic adjustments on ARMs can lead to decreased rates and lower monthly repayments, thereby taking away the need to think about refinancing every time there is a drop in interest rates. This, though, would not be the case if interest rates start to rise again.
If you have an adjustable-rate mortgage and are planning on making a switch, you need to pay attention to a few important aspects. These include knowing what index your interest is linked to and how often the rate adjusts, as well as the first, the annual, and the lifetime cap. To determine if a fixed-rate mortgage is better for you, it is important to do the math ahead of time.
Are You Refinancing to Consolidate Your Debt?
Whether or not you should refinance your home to consolidate your debt depends on your existing financial situation. Refinancing your mortgage with the sole aim of consolidating your debt might not be in your best interest if you don’t have your finances in order. While repaying your high interest debt using proceeds from a low interest mortgage might seem like a logical move, there are pitfalls you need to consider.
One downside is that you basically transfer your unsecured debt from credit cards and personal loans into a secured debt that uses your house as collateral. If you end up defaulting on your repayments, you stand to lose your home. While not repaying your unsecured debt does come with unfavorable consequences, you don’t have to worry about losing your home.
Another problem comes in the form of debt that you feel you have repaid, but what you’ve essentially done is simply transferred it to another loan. With your credit cards seemingly all paid off, you might be tempted to spend again, and create even more debt in the process.
Has Much Has Changed Since Your Last Closing?
Has there been any significant change in your creditworthiness since the closing of your last mortgage? If your credit score has improved considerably, you might qualify for an even lower interest rate. However, if your credit score has dropped, it might have an adverse effect on the rate you get. If you’re still thinking about refinancing, you might want to take some measures to fix your credit first.
The Pros and Cons of Refinancing
Refinancing a home loan is not a foolproof process, and it comes with its share of benefits and drawbacks.
Possible Pros
- Lower interest rate
- Lower monthly repayments
- Decrease loan term by paying it off sooner
- Change the type of mortgage you have
- Consolidate your debt
- Make use of the equity you’ve built to take cash out
Possible Cons
- Completely resetting the mortgage may lead to a longer loan term
- High closing costs
- Further drop in rates might result in you going through the entire process again
- Can take anywhere between 15 to 45 days to fall through
Conclusion
With interest rates showing slight signs of revival as of now, people who are thinking about refinancing their mortgages might have to make some quick decisions. However, there is no sure fire way to tell which way interest rates will move in the coming future. What can be said with certainty, though, is that a low interest rate atmosphere gives existing mortgage holders the ability to potentially save some money by going the refinancing way.
To make sure you choose the right lender, look at more than just the interest rate on offer. Other aspects that need your attention include the fees you need to pay, customer service levels, as well as flexibility in terms and conditions.
DISCLAIMER:
30-YEAR FIXED-RATE MORTGAGE: THE PAYMENT ON A $200,000 30-YEAR FIXED-RATE LOAN AT 3.875% AND 80%LOAN-TO-VALUE (LTV) IS $940.14 WITH 0 % POINTS DUE AT CLOSING. THE ANNUAL PERCENTAGE RATE (APR) IS 4.026%. PAYMENT DOES NOT INCLUDE TAXES AND INSURANCE PREMIUMS. THE ACTUAL PAYMENT AMOUNT WILL BE GREATER. SOME STATE AND COUNTY MAXIMUM LOAN AMOUNT RESTRICTIONS MAY APPLY.
