There are as many reasons to refinance as there are types of loans. Some homeowners want to lower their interest rate, to shorten the length of their loan, to convert from an adjustable-rate to a fixed-rate mortgage, to draw on the equity they’ve built in their home to fund a financial emergency or opportunity, to finance a large purchase or to consolidate debt.
Buyer: Jane Doe of Edwardsville, IL
Home: $150,000 single family ranch
Loan: 30-year fixed-rate for $120,000 at 9%
Refinance: 15-year fixed-rate at 5.5% APR
Change in monthly payment: $805 to $817
One of the most popular reasons for refinancing, lowering your interest rate by even a percentage or two can save money, reduce your monthly payments and help you build equity faster. By refinancing to a shorter term, you can significantly lower your interest rate without dramatically changing your monthly payment.
Adjustable-rate mortgages (ARMs) typically start out offering a low rate for a set amount of time. When that time is up, the rate adjusts based on market conditions, usually going up. This is the perfect time to refinance to a lower-interest, more predictable fixed-rate mortgage. If you started out with a fixed-rate mortgage but don’t plan to stay in your home for more than a few years, you might want to refinance with an ARM to take advantage of falling interest rates.
If you’ve built a decent amount of equity in your home, you may qualify to refinance and draw on that equity for a number of other expenses: paying down high-interest rate credit cards or loans, paying college tuition, starting a business or remodeling your home. Before applying, discuss the risks and rewards with your lender to make sure this kind of loan is right for your situation.
Home buyers who lack the standard 20% down payment often turn to piggyback or 80-10-10 loans, taking out one loan for 80% of the home price and a second mortgage for 10%. The buyer provides the last 10% as a down payment. Often, the second loan has a higher rate than the primary loan. Refinancing can allow you to consolidate both loans under one more manageable interest rate.
If your finances allow, shortening your 30-year loan to 15- or 20-years can save considerable money over the term of the loan. Or, if your income has been reduced, switching to a longer-term loan can help lower your monthly payments.
For home buyers who want a conventional mortgage but are unable to make a 20% down payment, lenders often require PMI to cover their loss in case the buyer defaults on the loan. Lenders may require PMI coverage for a certain length of time or until the buyer has built 20% equity in their home. You may also qualify for a refinance loan that doesn’t require you to pay costly PMI premiums.
So, you’ve done some research, and you’re feeling confident that you have the financial and mental resources to refinance. This is where your homework really begins.
Of all the many loans and lenders out there, which are right for you? Even if you can significantly lower your interest rate while keeping the same type of loan you already have, that may not be your best choice. Begin by understanding the options.
Offering a consistent interest rate throughout the length of the loan, fixed-rate mortgages are some of the most popular. Typically available in 30-, 20- and 15-year terms, some fixed-rate loans provide a cash-out option allowing you to draw on the equity in your home.
A 30-year fixed rate is a great choice if you plan to stay in your home for several years and have enough equity to avoid paying for private mortgage insurance. Because loan payments are stretched out over 30 years, your monthly payments may be lower, but you will pay more interest.
A 20-year fixed rate condenses your payments over a shorter time, allowing you to save interest by paying off your loan 10 years sooner.
You’ll pay considerably less interest with a 15-year fixed rate mortgage and build equity much more quickly. But your monthly payments will be noticeably higher.
With an interest-only loan, you’ll pay only interest for the initial part of the loan. Once the interest is paid off, you’ll start paying down the principal. These loans aren’t a good fit for most borrowers. But if you want low monthly payments, don’t expect to stay in the home for more than a few years and expect your income to grow, you may want to ask your lender about your interest-only options.
Offering a low initial interest rate, a 30-year ARM will adjust to a fully indexed rate after a set period of time, usually 5, 7 or 10 years. This introductory rate is typically lower than fixed-rate loans, making it a good option for buyers who plan to sell their home before the rate adjusts up.
Many of the mortgage loans offered by the U.S. government are designed to help borrowers successfully achieve home ownership with manageable loans for borrowers in a variety of financial situations.
Insured by the Federal Housing Administration, an FHA loan can be a great option for borrowers with poor credit or limited savings who may not qualify for many traditional fixed-rate loans. Although the credit requirements are less stringent, you will be required to buy private mortgage insurance if you do not have 20% equity in your home.
If your current FHA loan is in good standing, an FHA Streamline Refinance may be a good choice if you’re looking to quickly lower your interest rate and monthly payment without an appraisal.
The Veteran’s Administration offers several refinancing options for borrowers who currently hold a VA loan or are eligible to get one.
If you’re hoping to tap into the equity in your home, a cash-out VA refinance will allow you to access up to 90% of your home’s current value.
If you currently have a conventional or ARM loan and want to switch to a VA loan, a rate-term refinance is a fixed-rate loan that allows you to finance up to 100% of the home’s value without mortgage insurance.
Lower your interest rate and change the terms of your loan. With no out-of-pocket costs or appraisals required, an Interest Rate Reduction Refinance Loan (IRRRL) offers streamlined refinancing for borrowers with a VA loan.
Now that you have an idea of what kind of refinance loans are available, it’s time to start vetting lenders. If you were pleased with the experience you had working with your current mortgage provider, you’ll want to include them on your list of candidates.
Before you start making calls or surfing websites, consider what features are most important to you: lowest rates, fast closing times, online convenience, or in-person customer service? No one lender will be a perfect fit for every borrower. So, list your priorities and seek out mortgage lenders who share them.
Ask neighbors, friends and colleagues for recommendations—or warnings. Check out online reviews. Contact lenders by phone, email or online, and start asking questions.
Every state in the country requires Mortgage Loan Originators to maintain a current license. To verify licensing, visit the Nationwide Multistate Licensing System website, NMLS Consumer Access Website.
Mortgage lending is a complex business with ever changing products, regulations and rates. Find someone who’s closed a wide variety of loans for borrowers like you.
Ask for three references from former clients—and follow up with them. Talking with someone who’s been there, done that with the lender you’re considering can boost your confidence that you’re making the right decision.
Whether you prefer interacting by phone, email, text message or carrier pigeon, will they communicate with you how and when you’re most comfortable? Refinancing is life-changing decision. You deserve to work with a firm and a Mortgage Loan Originator you can trust. USA Mortgage Loan Originators are available to their clients 24/7.
Don’t hesitate to ask for estimates—it’s your financial future on the line. And, it could save you a substantial amount of money and hassle over the life of your loan. According to the Federal Home Loan Mortgage Corporation (also known as Freddie Mac,) “…borrowers could save an average of $1,500 over the life of the loan by getting one additional rate quote and an average of about $3,000 for five quotes.”
Once you’ve narrowed down your list of preferred lenders, request a Loan Estimate from the top 3 to 5 firms. They will respond with a Loan Estimate, formerly called a good faith estimate, which is a simple, three-page document spelling out the specifics of the loan they are proposing, including:
- Loan amount
- Term length
- Total closing costs
- Interest rate
- Tax and insurance costs
- Repayment penalties, if applicable
- Origination charges
This allows you to accurately compare loans from different lenders, so you can make a confident and educated decision. Lenders are required to give prospective borrowers their Loan Estimate within three days of receiving your application. Submit your applications within a narrow time frame to ensure each lender is estimating based on the same market conditions. Your credit score should not be affected provided you submit your applications in less than 30 days.
*Estimates provided for illustrative purposes only. This does not represent a commitment to lend. Your actual rate, payment, and costs could be higher. Get an official Loan Estimate before choosing a loan.
Here’s where you get down to the details to determine which estimate, if any, is right for you. Compare your Loan Estimates to each other as well as to your current mortgage. Reviewing what you’ve paid in interest so far and what you will pay on your current loan, versus the refinance, will give you a solid idea of your total loan costs for each option.
You’ll find a variety of refinance loan calculators online to help you crunch the numbers. Most lenders offer one on their websites. USA Mortgage has one you can use here.
Pay close attention to closing costs, as this will be a big factor in how quickly you’ll begin to see savings with your new loan. Plus, you will need to pay closing costs in full on the day you close.
Use this simple formula to calculate the break-even point on the loans you are considering:
Total closing costs divided by the monthly savings your new loan will provide.
Use this simple formula to calculate the break-even point on the loans you are considering:
To calculate your break-even point, run the numbers on each loan estimate you are considering to determine whether or not the loan meets your needs.
Total closing costs: $4,800
Amount saved per month: $160
Time required to fully recover closing costs: $4,800 / $160 = 30 months
As you compare estimates, remember that rates change daily, even hourly. Just because a lender posts a great rate on their website doesn’t mean that will be the rate you get when you apply. You can and should ask the lender to lock the rate in their estimate for an amount of time. You’ll need to apply for the loan before the lock expires to get that rate.
Be sure to consider the tax deduction you’ll receive with the new loan versus your current one. Mortgage interest is tax deductible and can provide a sizeable savings for many borrowers. Talk with your tax advisor to make sure you won’t pay more in taxes by refinancing your home.
Refinancing a home is one of the biggest financial decisions you’ll ever make. Stay vigilant to avoid these common mistakes that can cost you time and money over the course of your loan.
It’s not all about the interest rate.
Many factors go into the final cost of your loan. Closing costs, fees, points, all can affect what you end up paying over the term of your loan. Some lenders may offer appealingly low interest rates meant to distract you from excessively high fees. Some advertised rates are based on the borrower paying points to lower the rate, adding to the up-front cost of the loan. Ask your lender about loan origination fees, points, credit reports and all other fees before you submit your application.
How much are you really saving?
If you’re not getting at least .75 to 1.00% off your current interest rate, refinancing may not be worth the effort—unless you have a high-end home which would bring higher savings or you plan to stay in the home for a long time.
Don’t wait for the lowest rate.
Even the most experienced mortgage lenders find it tough to predict when and how much rates will change. Trying to time your mortgage to get the very lowest rate could cause you to miss a good opportunity. Ask the lenders you’re looking at to lock your rate to ensure you’re getting the loan you need and want.
Understand the estimates.
You’ve taken the time to get several loan estimates. Take the time to carefully review them. Compare the terms, closing costs and fees. And compare each lenders’ estimate against what they promised before you applied. If there are major discrepancies, you may want to delete them from your short list.
Go easy on your equity.
Compared to other types of loans, refinancing loans offer lower interest rates. Plus, your interest payments are usually tax-deductible. If you need cash for home repairs or other large purchases, a refinancing loan that lets you draw on your home equity sounds like a no-brainer. Just be careful not to take too much out in case housing prices fall. Otherwise, you could find yourself in a tight financial squeeze trying to make your monthly payments.
Don’t overextend yourself.
Most homebuyers initially opt for a 30-year mortgage. While it can significantly lower your monthly payments, refinancing with another 30-year loan can put you back where you started and increase the amount of interest you’ll ultimately pay. Instead, ask your lender for a shorter-term loan matching the time you had left on your original mortgage. Say you’ve been paying on your home for seven years. Refinance with a 23- or 20-year loan instead of a 30. Not only will it lower your interest rate, it could shave years off your mortgage without raising your monthly payments.
Avoid penalties for paying off your loan early.
To compensate for the loss of interest, some mortgages charge a penalty if you pay off the loan ahead of schedule. Of course, this is exactly what refinancing does. While it can help borrowers with poor credit secure a mortgage, make sure the penalty will expire within 3 to 5 years from the start of the loan.
Beware of junk fees.
Before accepting a loan, scour the estimate for junk fees added to the closing costs. Charges for document preparation, document delivery, or excessive fees for obtaining credit reports are signs your lender is trying to squeeze more fees out of your loan. If they are charging you for simple tasks you could have done yourself, chances are it’s a junk fee and worth negotiating out or even choosing a different lender.