Even though low mortgage interest rates may encourage some homeowners to reorganize their finances, you should decide whether or not to refinance your mortgage based on your financial situation. The mortgage rates for this week shouldn’t be what makes you decide whether or not to refinance.
Before you apply for a home-refinance, there are nine important things you should think about.
1. Know how much your home is worth
The first thing you’ll need to do is figure out how much equity you have in your home. If your house is worth less now than when you got your mortgage, which is called “negative equity,” it doesn’t make sense to refinance it.
At the end of the second quarter of 2021, consumer confidence was at its highest level since the COVID-19 pandemic began. CoreLogic, a company that keeps track of property information, says that this means that the equity of many homeowners has gone up a lot. A recent report shows that the equity of U.S. homeowners with mortgages, which is about 63 percent of all properties, has gone up by 29.3 percent year over year (YOY) since the second quarter of 2020. This is a total gain of more than $2.9 trillion and an average gain of $51,500 per borrower.
This means that the number of homeowners with negative equity has gone down a lot in the last year. In the second quarter of 2020, 3,3% of all mortgaged homes, or 1.8 million homes, had negative equity. In the second quarter of 2021, this number dropped by 30% or 520,000 properties.
Still, some homes haven’t gotten back to what they were worth, and some owners have low equity. Conventional lenders don’t always let you refinance with little or no equity. But there are government programs that can help. The best way to find out if you are eligible for a certain program is to talk to a lender about your specific needs. If a homeowner has at least 20% equity in their home, it will be easier for them to get a new loan.
2. Know how good your credit is
In the past few years, lenders have made it harder to get a loan. Some people may be surprised to find out that even if they have great credit, they don’t always get the best interest rates. For the best mortgage interest rates, lenders usually want to see a credit score of at least 760. People with lower scores can still get a new loan, but they may have to pay more in fees or interest.
3. Know your ratio of debt to income
If you already have a mortgage loan, you might think that getting another one won’t be hard. But lenders have not only raised the bar for credit scores, but they have also become stricter about the ratio of debt to income (DTI). Some things can help you get a loan, like having a high income, a long and stable work history, or a lot of savings. However, most lenders want your monthly housing payments to be no more than 28 percent of your gross monthly income.
Overall, your DTI ratio should be 36 percent or less, though some lenders will go up to 43 percent if you have other good things going for you. To be eligible, you may need to pay off some debt first.
4. How much does it costs to refinance
Most of the time, it costs between 3% and 6% of the total loan amount to refinance a home. However, there are ways for borrowers to lower these costs (or wrap them into the loan). You can add the costs to your new loan if you have enough equity (and thus increase the principal). Some lenders offer a “no-cost” refinance, which usually means that you will pay a slightly higher interest rate to cover the costs of closing. Don’t forget to negotiate and look around, because some refinancing fees can be paid by the lender or even lowered.
5. Rates vs. the Term
While most borrowers focus on the interest rate, it’s important to know what you want to get out of refinancing so you can choose the right mortgage product. If you want to make the smallest possible monthly payments, you should get a loan with the lowest interest rate and the longest term.
If you want to pay less in interest over the life of the loan, look for the lowest interest rate in the shortest term. If you want to pay off your loan as quickly as possible, you should look for a mortgage with the shortest term and affordable payments. A mortgage calculator can show you how your monthly payment changes when the interest rate changes.
6. Points for refinancing
Make sure you look at both the interest rates and the points when comparing different mortgage loan offers. To lower the interest rate, people often pay points, which are equal to 1 percent of the loan amount. Make sure to figure out how much you will pay in points for each loan, as these fees will either be paid at the closing or added to the new loan’s principal.
7. Know when you start making money.
The breakeven point is an important number to figure out when deciding whether or not to refinance. This is the point at which your monthly savings have paid for the costs of refinancing. After that, you can do whatever you want with the money you save each month. For example, if the cost of your refinance is $2,000 and you save $100 per month compared to your old loan, it will take you 20 months to make up the difference. If you plan to move or sell your home in the next two years, it might not make sense to refinance.
8. Home mortgage insurance
When they refinance, homeowners who have less than 20% equity in their home will have to pay private mortgage insurance (PMI). If you are already paying PMI on your current loan, this won’t change much for you. But if they refinance their mortgage, some people whose homes have lost value since they bought them may find that they have to pay PMI for the first time.
If you refinance, your payments may not go down enough to cover the extra cost of PMI. A lender can quickly figure out if you need PMI and how much it will add to your monthly mortgage payments.
9. Understand your taxes
Many people have used the deduction for mortgage interest to lower their federal income tax bills. If you refinance and start paying less interest, you may get a smaller tax deduction. (It’s important to remember that most people don’t think that’s a good enough reason to not refinance.)
But it’s also possible that the interest deduction will be higher for the first few years of the loan (when the interest portion of the monthly payment is greater than the principal). Taking out cash or adding closing costs to your loan will make it bigger, which will also change how much interest you pay.
The Tax Cuts and Jobs Act (TCJA), which was signed into law in December 2017, may make it harder for you to take the mortgage interest deduction. The new higher standard deduction—$25,100 for married couples filing jointly in 2021, up from $12,700 under the old law—may make it less financially appealing for more taxpayers to itemize their deductions.
Rich homeowners who want to refinance a large existing mortgage will still be able to deduct interest on up to $1 million in mortgage debt, but the limit for new mortgage debt is now $750,000 for homes bought on or after December 15, 2017. Because of these changes, it’s best to talk to a tax professional about how refinancing will affect your taxes.
How much does it cost to refinance your home?
In 2020, the average cost to refinance a mortgage on a single-family home was $3,398, according to ClosingCorp. In general, closing costs will cost you between 2% and 6% of the loan’s principal amount. For example, if you refinance a $200,000 mortgage, your closing costs could be anywhere from $4,000 to $10,000.
How many points do you need on your credit score to refinance your mortgage?.
Different mortgage types and lenders have different credit requirements. For the best mortgage interest rates, lenders usually want to see a credit score of at least 760. Those with lower scores can still get a new loan, but they may have to pay more in fees or interest.
For most types of conventional mortgage refinancing, you’ll need a credit score of at least 620. But for some government programs, you need a credit score of at least 580 or none at all.
Can I use the same bank to refinance?
The short answer is yes, but it might not be the best choice. There are some good things about refinancing with your current mortgage lender: They may offer you a good deal to stay with them since they already have your information. On the other hand, if you want to get the best deal possible, you should look around.
How quickly can I refinance my mortgage?
In general, you don’t have to wait a certain amount of time before you can refinance your conventional mortgage. In theory, you could refinance your home as soon as you bought it. But some lenders have rules that stop borrowers from immediately refinancing with the same lender.
Whether or not these rules apply to you depends on what kind of mortgage you have and who your lender is. Keep in mind that there is also a general requirement that you have a debt-to-income (DTI) ratio of 36 percent or less, which will take the average homebuyer (at least) a few years to reach.
How much equity do I need to be able to refinance?
Conventional wisdom says you need 20 percent to refinance with a conventional loan, but you only need 20 percent if you want to avoid paying mortgage insurance or plan to do a cash-out refinance.
Can I buy a car while I’m refinancing?
Mortgage experts usually say that you shouldn’t do anything that could affect your debts, income, or credit score while your application for refinancing is being reviewed. This could take weeks or even months. Even a one-point drop in your credit score can make a big difference in how much your mortgage will cost. When you apply for a mortgage, a lender will look at your DTI ratio, which includes your auto loans.
If you have to pay more each month because of your auto loan, your DTI ratio will go up, assuming everything else stays the same. Usually, you should wait to make this kind of purchase until your application is done.
Refinancing a mortgage is complicated, like many other financial transactions, and homeowners who want to do it need to do their research. Talk to a trustworthy lender to get quick answers to some of your worries. This will help you decide whether or not refinancing is the right choice for you. Do the research we talked about above to figure out if refinancing makes financial sense for you and if it seems like a good idea.