Does a mortgage refinance make sense? The answer to that common refinance question largely depends on your goals for your new mortgage and how long you plan to stay in your home.
Indeed, there are several benefits to refinancing:
- You can lower your monthly payment by taking advantage of lower mortgage rates
- You can choose a different loan product
- You can combine two mortgages into one
- You can pay off your mortgage quicker
Whether you are choosing to refinance to a record low mortgage rates to lower your monthly payments or you’re refinancing from an ARM to a fixed rate, each refinance decision comes with its own set of questions and considerations.
Here are answers to eight of the most common refinance questions:
No. 1: Will my refinance save me money?
Regardless of why you're considering a refinance, it's important to calculate all of the costs and potential savings before making a decision to determine if the refinance will actually save you money.
Refinance savings go beyond the break-even point to where you begin to save actual dollars on your refinance. If you're planning to sell your home within a few years, it may not give you enough time to break even on a refinance. Breaking even requires making enough payments at the lower payment to save more than the cost of refinancing.
It may be possible to refinance with no out-of-pocket costs, however, there is no break-even point since the refinance cost you nothing out of pocket. That said, there will be a smaller reduction in your monthly payment since that “no-cost” refinance comes with a higher interest rate or larger loan balance.
To calculate if and when your refinance will save you money, utilize HSH.com's refinance calculator. The calculator gives you the simple "break-even" calculation so that you know how long it takes to recoup your refinance costs, but it also provides additional information about how your total interest cost and loan balance will differ when you choose to refinance with either a traditional refinance, low-cash-out refinance or a cash-out refinance.
Examining the affect on your interest costs and loan balance is the best way to determine if a refinance will be beneficial to you over the long term.
No.2: Will a lower rate alone save me money?
Loan officers may provide you with a false sense of security by calculating your new payment if they simply subtract it from your current monthly payment and call that difference "savings." But that figure isn't exactly correct in terms of your actual savings.
If your mortgage is only a couple of years old, and you can refinance to a significantly lower interest rate, lengthening your mortgage term inflicts only minimal damage. However, if you are deep into your mortgage, trading a lower interest rate for a much longer term may not save you much at all. In fact, it could cost you more. If you are 10 years or more into a 30-year loan, consider refinancing to a shorter-term loan, say, 20, 15 or 10 years.
No. 3: Do I have to refinance with my current lender?
No, you don't have to refinance with your current lender. In fact, it's wise to get refinance quotes from several other lenders before talking with your current lender.
Some mortgage lenders have retention programs they use to head off homeowners before they refinance with someone else. However, the deals they offer may not be as good as what you may find by shopping the open market. In addition, your mortgage lender may have less incentive to close your refinance quickly because it already has you as a customer with a higher interest rate.
In some cases, it is possible to leverage offers from the open market to get your current lender to cut you a deal.
For example, Janet Walker, a mortgage borrower from Phoenix, Arizona, did get her current lender to lower her mortgage rate, but not until after they made her work for it.
"I called to get my mortgage balance because I wanted to look into refinancing. My lender called me the next day offering to lower my rate. But then they said it would involve a whole application process and paying for an appraisal, and the rate they offered wasn't the best available. I shopped around and told them I'd refinance elsewhere if they couldn't match a better deal that I'd found. They finally did, but it took a while to close the loan."
No. 4: How will my home value affect my refinance?
If your home value has dropped, or if you're underwater, you still have some refinance options. But first, you'll need to know how much equity you have in your home.
Local real estate agents can provide an estimate of your current home value. Once you have that information, you can divide your mortgage balance(s) by your home's value to determine its loan-to-value ratio (LTV). For example, if your home is worth $200,000 and your mortgage balance is $150,000, your LTV is 75 percent.
If your current mortgage is backed by the FHA or VA, you can apply for a streamlined refinance and your home's value will not be a factor. Although the Home Affordable Refinance Program (HARP) ended on December 31, 2018, if your mortgage is owned by Fannie Mae or Freddie Mac, you may be able to refinance through the Streamline Refinance Programs that replaced it.
Other options are conventional-to-FHA refinancing (allowed up to 96.5 percent LTV), conventional-to-VA refinancing (to 100 percent LTV), or "cash-in" refinancing, in which you pay cash to reduce your mortgage balance before you close on your refinance.
No. 5: How will my credit score affect my refinance?
Today's tighter lending standards make refinancing difficult if your credit score is low.
Before shopping for a refinance, it's worth checking all three of your credit reports and scores with the major credit bureaus Experian, Equifax, and TransUnion. Although mortgage lenders may approve mortgage loans for borrowers with compromised credit, getting the best mortgage rates usually requires a credit score of 740 or above.
According to Ellie Mae’s latest origination report, the average FICO score of borrowers who successfully refinanced a conventional loan was 735, while successfully refinanced FHA loans had an average score of 663. In general, though, Fannie Mae and Freddie Mac will back loans with scores as low as 620, but risk-based fees will drive up the rate available to a low-score borrower, making it less beneficial to refinance. FHA will theoretically back loans with scores even lower than Fannie or Freddie, but lenders are wary about making too many mortgages to weak credit borrowers.
No. 6: Should I refinance to the lowest mortgage rate possible?
Many, many people have made refinancing decisions that they regretted because they based their decision solely on finding the lowest rate possible. Ask most people who took out Pay Option ARMs with those tempting 1 percent payments how they feel about them now, and you're likely to get an earful of expletives!
But refinancing for a lower payment is a valid choice as long as you know what you are getting into and have plans to deal with potential rate changes down the road.
For example, while FHA mortgage rates are about 0.30 percent lower than conventional rates, there are added fees to consider with an FHA loan which could make it more expensive. Likewise, the 5/1 ARM is closer to a half-percentage point lower than a conventional 30-year, but you must determine the future effects of rate reset with an ARM after the fixed period expires.
No. 7: Should I consider a no-cost refinance?
There really is no such thing as a no-cost refinance. Your costs are rolled into your balance, paid by you, or absorbed by the lender in exchange for a higher mortgage rate. Not that a no-cost refinance is necessarily a bad thing, especially if you don’t have the cash on hand to pay closing costs, but if you want the lowest mortgage rate and the best long-term deal, you'll have to pay some fees. To learn the best way to pay for your refinance, use HSH.com's Tri-Refi Calculator.
No. 8: What if I can’t refinance at all?
If you simply can’t refinance your mortgage you’re not out of luck. Prepaying your mortgage is a financial strategy that saves you on interest cost over the long-haul, lowering the effective rate you pay and essentially replacing the need to refinance.
HSH.com’s prepayment calculator will show you just how much you can save.
(Gina Pogol and Richard Barrington contributed to this article.)
More from HSH.com:
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- HSH.com’s Prepayment::Refinance calculator
- 12 ways to get the lowest mortgage refinance rates
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- What is a rate and term refinance?
Homeowners have a variety of reasons for refinancing and each reason can indicate that one refinance option or another makes the most sense.
- Streamline Refinance Program to Replace HARP
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- What is HARP and do I qualify for a HARP loan?
Thousands of homeowners are still eligible to refinance under HARP. Are you one of them? Time is running out!