How do you know if it's time to refinance?Submitted by Mission Financial Planning on June 19th, 2020
I saw the lowest mortgage rates I’ve seen in a long time this week. With rates this low, it’s time to check to see how much you could reduce your monthly mortgage payment or speed up your pay-off date.
How do you know if it's time to refinance?
It's worth exploring refinancing if:
mortgage rates are at least half a percentage point better than what you currently have,
you think your house will appraise with 20% equity,
your credit score is healthy,
you have solid income for the last two years,
you are planning on being in the house for a while.
Before you do anything else, find out if your current mortgage can be modified (recast); some loans allow their terms to be changed for a nominal fee and principal reduction. This is often less expensive than refinancing and can accomplish the same goal.
To get started with refinancing, shop mortgage rates. This is important.
According to a recent study by LendingTree, people who called five lenders to compare refinancing rates saw differences of up to 1.32% between the lowest and highest rates quoted. This is a significant savings over the length of the loan.
The easiest way to compare loans fairly is to look at the APR (Annual Percentage Rate) which includes the basic interest rate, but also takes into account the fees that the lender will charge for the loan.
In addition to shopping interest rates, ask what additional costs and fees would be incurred in the refinance. Closing costs will be around 2% of your mortgage balance. Sometimes you’ll get a very low interest rate quoted “with points”. Points are fees paid directly to the lender up front in exchange for a reduced interest rate. This is also called “buying down the rate”. Points may be worth paying IF you’re going to be in the house for a long time.
One of the expenses of refinancing is getting an appraisal. This is to determine how much equity you have in your home. The best rates are available for people with at least 20% equity in their home. The house can’t be under construction or being remodeled, it needs to be in finished condition.
In addition to enough equity, you need enough income. The lender will look at two ratios: your housing-debt-to-income ratio (should be 28% or less) and a total debt-to-income ratio of 36% or less.
Once you’ve chosen the best rates and you have qualified for the loan, you need to decide how long you want your loan to be. A 30-year mortgage will give you the lowest monthly payment but remember that you have probably been paying down your old 30-year mortgage for a number of years. You may be trading a mortgage with only 20- or 25-years left for a new 30-year mortgage, extending your current pay-off date by years. If you can, consider a 20-year or 15-year mortgage; you’ll pay off the mortgage closer to your original schedule, probably with similar (maybe slightly bigger) payments.
Plan on providing the lender a lot of documentation, including tax returns, W2s and paystubs, bank statements, and your credit history. It seems like it gets more cumbersome every year.
If you’re retired, the lender will look at Social Security, pensions and withdrawals from retirement accounts. Withdrawals from savings accounts don’t count, you may need to set up a few months of automatic withdrawals from an IRA to qualify; you may also need to prove that you have enough in the IRA to cover three years of monthly income at that withdrawal rate.
If you’re self employed even more documentation will be required.
If you are borrowing more than $510,400* you may have to get a Jumbo (non-conforming) loan. Right now they are harder to get and more expensive. Some address this problem by getting a conforming first mortgage for the first $510,400, and using a second mortgage for the rest.
If we can help you through the process of comparing loans or deciding whether to refinance, please give us a call.
*The Jumbo mortgage limit is higher in some states.