Should I refinance now?
As you probably know, mortgage rates fluctuate, responding to what is going on in the economy as a whole. When rates go up, you may find yourself looking at loan programs that could help you save on your monthly payments. And when mortgage rates drop, many homeowners are able to cut their monthly mortgage payments by thousands of dollars a year through a simple refinance.
A refinance (or refi) lets you replace your original mortgage agreement with a new contract that contains updated terms and rates that you find more attractive. That means if rates come down since you closed on your initial mortgage, you can refi into a lower rate and potentially pay less each month.
While there’s always some organization and effort required to obtain a refi, the benefits far outweigh the time commitment, especially when you’re working with an easy-to-use digital platform that makes getting a refi a simple, pain-free experience.
Refinancing and interest rates
It’s best to begin any refinance journey by understanding the relationship between the interest rate you received when you originally purchased your home, and the rates currently available in the marketplace. You’re looking for a lower mortgage rate, low enough that after closing costs and associated fees you can lock-in tangible savings. Your lender can help with that.
Taking a step back for a moment, it’s worth outlining that there are four main costs that comprise your monthly mortgage payment, known as PITI.
4 parts of PITI
- Principal
- Interest
- Taxes
- Insurance
Out of these four, the only one you can hope to alter with a refi is the interest payment. But that doesn’t mean a refi can’t deliver transformative savings. Interest payments, as any homeowner knows, are a substantial recurring expense and they can eat into monthly budgets with unerring regularity. Think about it for a moment: If you were presented with an opportunity to reduce the amount of interest you pay by $50, $100, $200 a month, you’d certainly look into it, right?
What kind of refinancing makes sense to you?
There are multiple motives for contacting your lender and refinancing your home. The most straightforward reason would be to save on your monthly mortgage payment. But a refinance gives you financial options that can do more than simply reduce your monthly costs.
For example, you may want to leverage existing equity as part of a cash-out refinance to help consolidate debts, pay college tuition or make a significant purchase such as an investment property. A cash-out refi* can also help you access funds for home renovations—something that’s increasingly popular.
Then there’s the loan product itself. Maybe you’re apprehensive about a future spike in interest rates and want to get out of that adjustable rate mortgage while the going is good. Many homeowners are doing just that and switching to a fixed rate mortgage with low interest rates and greater predictability. Clearly, refis can be empowering; they can allow for savings and they promote flexibility.
Let’s take a deeper look at some of these refinance options.
Rate-and-term refinance
This is your basic refi and it’s the one that most people are rushing to obtain while mortgage rates remain attractive. The appeal is considerable. Even by adjusting your mortgage rate by a mere 1.0 or 0.5% percent, you could potentially reap considerable savings on both a monthly and annual basis—but the real savings are over the life of the loan. Sometimes many thousands of dollars could be saved.
You can run your refi numbers using our Refinance Calculator and find out how much less interest you could pay by refinancing to today’s rates.
Switch from an ARM to a fixed rate
An adjustable rate mortgage (ARM) certainly has its appeal. It’s a type of mortgage that combines an initial period (typically, 5, 7 or 10 years) consisting of a low fixed rate followed by an adjustable rate period that resets every six months (or annually) based on general market conditions. During the adjustable period, rates can swing in either direction. This could mean savings or it could mean higher costs; no one has a crystal ball.
This is where a refinance comes in. Don’t like the original terms that set you up for 10 or 20 years of adjustable rates? No problem. Talk to your lender and change the terms (and if you like, the duration) of your mortgage.
Switch from a 30-year mortgage to a 15-year mortgage
Many homeowners are racing to refinance their home not only to get a more favorable interest rate or switch out of the unpredictability of an ARM, but also to change their amortization schedule to more rapidly pay off the loan in full.
That’s right. A refinance not only allows you to change from an ARM to a fixed rate (or vice versa) but also from a 30-year mortgage to a 15-year mortgage. This can be helpful in three key ways.
- A 15-year mortgage almost always comes with a more favorable interest rate.
- As you pay off your principal in larger chunks, you amass equity more quickly. This equity can be tapped for other purposes, if need be.
- A 15-year mortgage will allow you to pay off your mortgage more quickly, enabling you to put the bulk of homeownership costs behind you and begin enjoying your life without a mortgage hanging over your head.
And yes, monthly payments will increase as you transition from a 30- to a 15-year mortgage. That’s why an examination of personal finances is essential. For example, if your income has increased since you signed your original mortgage agreement, you may be in a good position to better absorb the increase, especially in light of a faster route to full ownership.
Cash-out refi
While not as common as a rate-and-term refi, the cash-out refi is a great way to leverage existing equity to acquire funds for home improvements, investments, one-off purchases or to consolidate debt and pay it off in one lump sum. Because you’re reducing equity you’re increasing risk, and lenders’ rates will reflect that. As a result, don’t expect to receive the same low rates that you would get with a rate-and-term refi.
However, there may be other advantages. When seeking a cash-out refi for certain home improvements, there are potential tax savings** that could be obtained. Inquire with your tax advisor to determine if any tax-related savings are applicable to your circumstances.
Like all the previously discussed refi options, a cash-out refi requires a completely new mortgage agreement as well as a thorough approval process that includes a credit check, credit score, an examination of debt-to-income ratio (DTI), income, available assets, etc. Making sure to get pre-approved by your lender is a handy way to accelerate and optimize the underwriting process.
One particular point of interest for lenders is loan to value or LTV. For most conventional cash-out refinances done via the guidelines set by Fannie Mae and Freddie Mac, the maximum LTV allowed is 80% before you’re forced to purchase private mortgage insurance (PMI) to offset the additional risk. This means that you can tap a maximum of 80% of the existing value of your home (value determined by an appraisal--not original purchase price) while having established a minimum of 20% equity through principal mortgage payments.
Under this refi recipe, it will likely take at least a few years to achieve the requisite 20% equity necessary to qualify for a cash-out refinance. If your monthly statement says you’re somewhere south of that figure, you’ll need to find another way to procure the funds. However, once you’ve passed the 20% threshold, you’re eligible for the loan if everything else is good to go.
Refi: A few things to consider
Refinancing your home—for whatever purpose—has a lot going for it. However, it’s not necessarily all smooth sailing. Let’s look at a couple things to bear in mind when considering a refi:
- Appraisal: You will need to conduct a home appraisal at your own expense. Not a big deal, but it’s particularly important in the context of a cash-out refi as the appraised value of your home will determine how much money you can take out. While a well-maintained home in a nice neighborhood tends to appreciate, there are no guarantees.
- Credit examination: Maybe you thought you’d be exempt this time around having undergone this scrutinizing process during your original mortgage. Think again. Everything from your latest credit score, DTI, income and available assets will be reviewed to ensure you’re a low-risk candidate with proven creditworthiness.
- Seasoning period: Let’s say you just purchased your home and then read online that mortgage rates fell 1%; you might want to take the opportunity to lock-in a lower rate by refinancing your mortgage, right? Good idea, but there’s a hitch: Although Fannie Mae and Freddie Mac don’t typically object, your lender may require a waiting period of up to 120 days before allowing you to refinance. This is the “seasoning period.” Choosing a new lender may alleviate that problem. Additionally, nonconventional mortgages such as those offered by the VA and FHA have strict seasoning periods of 210 days. For USDA loans it’s 180 days.
- Closing costs: A refi isn’t an addendum to your original mortgage; it’s a whole new thing, and whether you're changing terms, changing rates or tapping equity for cash, your refinance will incur many of the same charges you had at the time of your initial mortgage, including closing costs that could total anywhere between 2-6% of the entire loan. This shouldn’t dissuade anyone from seeking a refi; it’s just prudent to know what’s in store.
Refi, FOMO and the lay of the land
When you stop and think about it, a refi is an extremely valuable tool to leverage for possible savings and financial flexibility. And this opportunity begins with the American Dream of homeownership. From there, it’s about building up equity and waiting for the opportune time to contact one of our loan officers and see if you’re a good candidate for refi savings.
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Applicant subject to credit and underwriting approval. Not all applicants will be approved for financing. Receipt of application does not represent an approval for financing or interest rate guarantee. Refinancing your mortgage may increase costs over the term of your loan. Restrictions may apply.
* Using funds from a Cash-out Refinance to consolidate debt may result in the debt taking longer to pay off as it will be combined with borrower’s mortgage principle amount and will be paid off over the full loan term. Contact Rate for more information.
** Rate does not provide tax advice. The consumer should always consult a tax advisor for information regarding the deductibility of interest and other charges in their particular situation.