Does a Refinance Make Sense? A Quick Guide
Refinancing a mortgage is the most common method to lower your monthly payments and give a homeowner some breathing room for their budget.
Determining when to refinance a mortgage to another loan that offers a lower interest rate or shorter loan period can be tricky and depends on your financial circumstances.
But there are several factors to consider before you obtain another mortgage.
Refinancing Is Another Mortgage
Refinancing means you are starting over another mortgage. If you’ve had a 30-year mortgage for 10 years, then you might be starting all over again.
Lower payment amounts can give you more flexibility in your budget and help you pay down higher interest debt such as credit cards.
Watch Mortgage Rates
Mortgage rates remain above 5% even though consumer demand has started to decline as the higher rates are pricing out many buyers, especially people shopping for their first home.
The 30-year mortgage rate this week is 5.22%, down from June's 14-year high of 5.81%, while the 15-year mortgage is 4.59%, according to Freddie Mac data. The 5/1 ARM., which means the interest rate resets after five years, is 4.43%.
Track mortgage rates before you make a decision and estimate your new monthly payments.
More: Reach out to multiple lenders to see how much you can save with this tool. It pays to compare your options.
Prepare for Refinancing Costs
Refinancing your current mortgage means obtaining another mortgage and paying for closing costs again, which can easily add up to 2% to 5% of the mortgage loan. The closing costs include the title search, appraisal and origination and underwriting fees. Many of these fees can be negotiated.
Consumers need to consider all costs associated with the refinance process since lenders charge upfront fees to cover the costs of issuing a loan, said Steve Reich, chief operations officer of Finance of America Mortgage.
“It’s important that homeowners keep this in mind when budgeting,” he said.
Cash-out Refis, Home Equity Loans and HELOCs
The surge in home prices during the last two years has been an advantage for homeowners because they can take advantage of their property’s equity. The rise in equity or the value of a home minus the mortgage against it can be used to pay for renovations, education or eliminate debt.
A cash-out refinancing is a new mortgage a homeowner receives to obtain a lump sum payment which is useful if you need a larger amount of money and a lower interest rate to make renovations to the home.
Two other options include a second mortgage that borrows against the equity in your home - you can choose a lump-sum home equity loan or a home equity line of credit, or HELOC. One drawback is that both types of loans require you to pay closing costs and fees similar to a traditional mortgage.
“Homeowners should be sure to obtain a sound equity estimate before starting the process as the amount of equity available in their home can determine whether they are approved for a refinance and the interest rate,” Reich said.
Length of Stay
Consider how long you’re planning to stay in the home before you start the refinancing process which can be timely and expensive.
Consumers who have plans to move in a couple of years or upgrade to a larger home, the costs of refinancing may cost you more money in the long run.
“If homeowners don’t plan on staying in their home for a long time, which I’d define as at least long enough time to recover the costs of the refinance, then a refinance may not be their best option,” he said.
Freddie Mac/Fannie Mae Refi Fee Eliminated
The Federal Housing Finance Agency repealed the much-maligned half percentage point fee that was being tacked on to Fannie Mae and Freddie Mac mortgage refinancing loans, said Greg McBride chief financial analyst for Bankrate, a financial data company.
The fee meant homeowners paid one-eighth percentage point in a rate, which was enough to “siphon $20 per month in potential savings out of the pockets of borrowers with a $300,000 loan,” he said.
The homeowners that were impacted included ones that were not high risk and did not need forbearance or payment relief during the pandemic.
“Repealing this ill-conceived and misappropriated fee is a win for borrowers and lenders alike,” McBride said. “Some of the savings will make it into the pockets of consumers but how much the borrower sees will be dependent on shopping around for the best deal.”
Credit Score Improvement
Consumers who have improved their credit scores since they initially took out a mortgage could benefit from a refinance because they are likely to receive a lower interest rate.
Before you plan to refinance you can work to improve your credit score by paying down a large credit card balance with a lump sum because it reduces your debt-to-available credit ratio. McBride said.
“But the biggest component of the credit score is whether or not you pay your bills on time so consistency in this area is critical,” he said.
If the opposite has happened and your credit score has dipped since the first mortgage, it is likely better to “hold off on a refinance until they can take steps to enhance their credit score and pay off debts,” said Finance of America's Reich.
The Bottom Line: Refinancing Your Mortgage Can Put Money In Your Pocket
Everyone’s situation is different, but there are many financial questions that a refinance can answer. Right now, those considering a refinance should know that interest rates are still at near-historic lows. Get approved to refinance and see expert-recommended refinance options from a trusted lender today.
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Ellen Chang is a Houston-based freelance journalist who writes articles for U.S. News & World Report. Chang previously covered investing, retirement and personal finance for TheStreet. She focuses her articles on stocks, personal finance, energy and cybersecurity. Her byline has appeared in national business publications, including USA Today, CBS News, Yahoo Finance MSN Money, Bankrate, Kiplinger and Fox Business. Follow her on Twitter at @ellenychang and Instagram at @ellenyinchang.