When mortgage rates go down, refinancing is a great way to save money on monthly payments and lower the rate on an existing loan.
Right now, mortgage rates are going up, and many homeowners no longer have the chance to refinance for this reason. Still, mortgage data company Black Knight says that more than 1 million homeowners could cut their current mortgage rate by at least 0.75 percentage points, even though the average rate is around 5%. On average, these homeowners could save about $316 a month on their mortgage payments.
Besides lowering your rate, there are other reasons to think about refinancing. You may want to lock in a long-term rate if your adjustable-rate mortgage’s fixed-rate period is coming to an end, or you may want to use the equity you’ve built up in your home to get cash from a cash-out refinance.
No matter why you want to refinance, you should get ready and start the process as soon as you can. ICE Mortgage Technology says that it took an average of 48 days to close on a mortgage in March. If you do these things, you’ll be on your way.
1. Set a goal for refinancing
Most people who own their homeowners refinance to get a lower interest rate and lower monthly payments. But that’s not the only reason why you might want to refinance.
There are pros and cons to each type of loan.
You might want to switch from an adjustable-rate mortgage to a fixed-rate mortgage to lock in a lower rate. If you want to pay off your mortgage faster, you might want to switch from a 30-year loan to a 15-year loan. If you switch from an FHA loan to a conventional mortgage and have enough equity, you may also be able to save money on mortgage insurance.
You might have big medical bills, unexpected home repairs, or other expenses that are putting a strain on your finances. If you have enough equity in your home, you can use a cash-out refi to not only refinance your loan but also get extra cash.
If you know what you want to do with a refinance, you can figure out what kind of mortgage product you need. Think about each choice to see which one works best for you.
2. Check the value of your home
Discover Home Loans says that you may be able to get a conventional refinance loan with as little as 5% equity in your home. Most lenders, though, want you to have at least 20% equity.
If you have more equity in your home, you may be able to get a lower interest rate and pay less in fees. This is because lenders see borrowers with more equity as less of a risk. If home prices go down, you are also less likely to owe more than the house is worth if you have more equity.
To get an idea of how much equity you have in your home, take the current mortgage loan balance off the current market value of your home. The result will be the value of your home. Talk to a local real estate agent who knows the area well to find out how much your home is worth. Zillow’s estimate of how much a house is worth can also be used as a rough starting point.
You should also get your home ready for an official appraisal, which is part of the process of applying to refinance. Keep records of any changes you’ve made to your home. (Did you add a bathroom or replace an old roof, for example?) To get your home ready to show, it won’t hurt to clean and organize it.
3. Look at your credit score and report.
Before you decide on a loan, you should check both your credit score and your credit report.
How good of a rate a lender will give you will depend a lot on your credit score. The better your credit score, the lower the rate you’ll be able to get and the less you’ll have to pay each month. If your credit score is low, look for ways to raise it before you apply for a loan.
Your credit score is based on the information in your credit report. It’s where you can look to see if any mistakes could hurt your credit score. If there are mistakes on your report, you can ask the credit bureaus to take them off. Be ready to show proof that the mistake was made.
As part of the CARES Act’s protections for consumers, you can get a free credit report every week from any of the three major credit reporting agencies until December 31, 2022. (Usually, each credit reporting company gives you one free report per year.)
You should also know what could cause your credit score to drop temporarily. If you apply for credit cards, personal loans, or auto loans right before, at the same time, or right after a refinance, your score will temporarily go down.
4. Use math to figure out if refinancing will be worth it.
Before you try to refinance, make sure you know how much a new loan will cost. Most of the time, closing costs for a refinance are between 2% and 5% of the total loan amount. For a refinance to make sense, you must be able to pay back the closing costs and save money over time.
You’ll need to figure out your break-even point to see if it’s worth it. This is the amount of time it will take for the money saved by the new loan to pay for itself. You can figure out when the loan will pay for itself by dividing the closing costs by the amount of money you save every month.
For example, if your closing costs are $5,000 and you save $100 each month, it would take you 50 months, or about four years, to break even. In this case, refinancing probably makes sense if you plan to live in your home for longer than four years.
A mortgage refinances calculator is a simple way to figure out if a refi is right for you.
5. Get your mortgage paperwork in order
To refinance, you need a lot of paperwork that shows you can pay for it.
You should have your most recent pay stubs, W-2s from the last two years, information about your current home loan, and details about your property taxes and home insurance.
If you are self-employed or have a job that is not typical, have your bank statements from the last two years ready. As proof of income, you may also need a profit and loss statement from your bank, 1099 forms from the last two years, and invoices from clients.
Depending on how they first look at your finances, a lender may need you to bring in more paperwork. Once you’ve chosen a lender, find out if there are any other things you need to do so you can get them ready ahead of time. If you do this, the application process will go much more smoothly.
6. Look for several mortgage lenders.
Don’t just take the first-rate of interest you’re given. You should look at the rates and terms of at least three different refinance lenders to see which one has the best deal for your needs. (A good place to start is Money’s list of the best mortgage refinance lenders.)
You should also think about the different kinds of lenders out there. Compare the rates of big banks, online lenders, and credit unions in your area. If you’ve been doing business with a bank for a long time and they offer home refinancing, check with them too. If you already do business with the lender in other ways, you might be able to get a better rate, but not always. Don’t assume that the loan you already have is the best deal.
7. Get your rate locked in
Lock in your interest rate once you’ve found a lender with the best terms and rate for you. A rate lock is supposed to make sure that your interest rate won’t go up before you close.
Rate locks, on the other hand, are usually made for 15 to 60 days. Since it takes lenders longer to close now, you may want to choose a longer lock. Some lenders won’t charge to lock in a rate, but others will. The cost to lock in a rate can range from 0.25 percent to 0.50 percent of the total loan amount. If your loan doesn’t close on time, you may have to pay more fees if you have to extend the lock period.
Timing is the key to a rate lock. Ask your lender how long it usually takes to close, and then lock in the rate for that long.