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Everywhere you turn right now, there’s a new wave of hype about mortgage refinancing. That’s all thanks to the Federal Reserve dropping interest rates by half a percentage point at the beginning of March 2020 and then dropping again mid-month to between 0–0.25%.1,2 Zero percent is pretty attention grabbing, but keep in mind that it doesn’t mean you can get a mortgage with 0% interest (wouldn’t that be nice).
All of this interest-rate shifting is in an effort to boost the economy in the middle of the coronavirus or COVID-19 (you’ve probably heard all about that, haven’t you?). Lower interest rates are great and all, but how do you know if it’s the right time for you to actually refinance?
One thing’s for sure, with rates this low, it’s worth taking the time to see what’s best for your specific situation. And you’ll sleep better knowing you’re making informed, well-thought-out decisions for you and your family and not just jumping on a bandwagon.
What the New Lower Interest Rates Mean for You
If you were already tossing around the idea of refinancing, these low rates couldn’t have come at a more perfect time. Getting a mortgage with a 1–2% drop in interest rate can make a huge difference in your monthly budget and ability to pay off your mortgage faster. And if you were thinking of refinancing from your current mortgage term down to a 15-year fixed-rate mortgage (the only one we recommend), now is the prime time to do it.
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And if you’re really serious about refinancing, be sure to actually submit a loan application. Some mortgage companies are overstating their published rates right now to slow down the swarm of people asking about lower rates.3 So be on the lookout for that. If you want to see the true low interest rate, your best bet is to submit the application.
Oh, and in case you’re wondering—just because mortgage interest rates are crazy low right now, that doesn’t mean you should roll up all your other debt (credit cards, student loans, etc.) into a refinanced mortgage. Nope. Just don’t. You want to pay off your smaller debts first (and get energized from those wins). Lumping your student loan debt into your mortgage means it’s going to take a lot more time to pay off those loans and your mortgage too. It puts you even further away from completing either of those goals. No thanks.
What Is Refinancing?
Refinancing is the process of getting a new mortgage by changing the terms of the one you already have on your home. You might be thinking of refinancing your mortgage for a few reasons—like taking advantage of lower interest rates, switching mortgage companies, reducing monthly mortgage payments, or using money from the refinance for a big purchase.
Don’t worry—refinancing doesn’t mean you end up with two mortgages! Instead, your first loan is technically paid off through the refinancing process and a second loan is created in its place.
How Does Refinancing Work?
To refinance your mortgage, you'll need to shop and apply for a loan—just like when you applied for your original mortgage. You could contact a lender directly, or use a broker to see if you’re approved and can qualify for refinancing.
To see if you would qualify, you’ll need to dig out some paperwork to make your case. Lenders look for different things, but generally, they want you to meet the following requirements:
A Maintained Original Mortgage: Lenders need proof that you’ve maintained and paid your original mortgage for at least 12 months before they’ll consider your loan for refinancing.
Equity: You’ll need to show you have at least 10–20% equity in your home.
Income: You have to prove you have a regular income, and lenders will also look at your debt-to-income ratio. Basically, they want to make sure you can still pay your bills based on the amount of money you make, and that any existing debt payments you have won’t interfere with your refinanced mortgage payment every month.
Credit Status: With lenders who ask for your credit score, having a lower credit score may result in higher interest rates.
But what happens when you don’t have any debt and no credit score? Don’t worry! Lenders like Churchill Mortgage will use a manual underwriting process to determine your risk or likelihood of paying your mortgage on time.
When To Refinance Your Mortgage
The time to refinance is when you want to make a less-than-desirable mortgage better with a new interest rate.
Do a break-even analysis to see if refinancing is something worth doing in your situation. A break even analysis means running the numbers on whether you’ll be in your home long enough to benefit from the savings that a lower interest rate and payment could bring.
Then you should work out how long it’ll take you to make up the closing costs you’ll have to pay for your refinanced mortgage. Yes, there will be closing costs—we’ll get to them soon!
In general, refinancing makes the most sense if you fall into one of these categories:
1. You Have An Adjustable Rate Mortgage (ARM)
With your ARM having interest rates that are adjustable, you might start off with the first few years at a fixed rate. But after that, the rate can adjust based on multiple factors like the mortgage market, LIBOR market index, and the rate at which banks themselves lend each other money. Bottom line is, ARMs transfer the risk of rising interest rates to you—the homeowner.
So, in the long run, an ARM can cost you an arm and a leg! (Yes, we went there.) That’s when refinancing into a fixed-rate mortgage could be a good financial move. It’s worth it to avoid the risk of your payments going up when the rate adjusts.
2. The Length Of Your Mortgage Is Over 15 Years
If your original mortgage is a 30-year term (or more), then refinancing is a good way to get to the ultimate goal of locking in a 15-year fixed-rate mortgage—ideally with a new payment that’s no more than 25% of your take-home pay.
But if your interest rate is low enough on a 30-year fixed-rate mortgage to compete with the 15-year rates out there, make sure refinancing just to get the shorter term isn’t going to cost you more. You’re better off making extra payments (and are committed to making them) on your 30-year mortgage every month to shorten your payment schedule.
Simply put, you want to own your home as soon as possible instead of your home owning you! Use our mortgage payoff calculator to run your numbers and see what your monthly payment would be on a 15-year loan.
3. You Have a High Interest Rate Loan
If your mortgage has a higher interest rate compared to ones in the current market, then refinancing could be a smart financial move if it lowers your interest rate or shortens your payment schedule.
If you can find a loan that offers a reduction of 1–2% in its interest rate, you should consider it. Remember to factor in your break-even analysis too! Refinance only if you’re planning to stay in your home for a long time, because it will give you time to make up those closing costs.
4. Your Second Mortgage Is More Than Half Of Your Income
A lot of homeowners with second mortgages want to roll it into a refinance of their first mortgage. But not so fast! If the balance on your second mortgage is less than half of your annual income, you would do better to just pay it off with the rest of your debt through your debt snowball.
But if the balance is higher than half of your annual income, you could refinance your second mortgage along with your first one. This will put you in a stronger position to tackle the other debts you might have before you pull your resources together to pay off your mortgages once and for all!
How Much Does It Cost To Refinance?
Depending on the lender, your home’s location, and the amount you borrow, closing costs for a refinance can range from 3–6% of the loan amount.4 So if your loan amount was $100,000, you could end up paying $3,000 in fees at a minimum.
Refinancing costs typically do not include property taxes, mortgage insurance and homeowner’s insurance because they were set up when you first bought your home. Remember, you’re revising the original mortgage, not starting completely from scratch.
Refinance closing costs include:
- Refinance application, a new home appraisal, and title search
- Home inspection fee
- Lender’s attorney review fee
- Origination fee
- Points fees
While you may not be able to avoid all of these closing costs, you can avoid mortgage points fees by asking for a par quote or zero quote. That means the closing cost estimates will not include points.
So, to get your break even analysis, let’s say your closing costs will be $3,000 (3%) on a $100,000 refinanced mortgage. And that your new refinanced interest rate is 1% lower than your previous rate. If we look at how much that 1% reduction would save you every year, it would take around three years to make up those $3,000 in closing costs.
And once you’ve made up the closing costs, you can enjoy the benefits of the lower interest rates through till the end of your mortgage term (or a time down the road if you decide to sell your home.)
Should I Refinance My Mortgage?
You can think about refinancing your mortgage if it means you’re locking in a lower rate of interest at a fixed rate or reducing your mortgage term length. The savings you could make from doing it for the reasons we outlined earlier could be used to help tackle the important stuff, like paying down debt or saving for retirement.
Refinancing is a good idea if it helps you take control of your monthly bills. You will feel more confident going forward if you have more money to put toward becoming totally debt-free. Plus, just imagine if you owned your home outright!
But there are times when refinancing your mortgage would not be a good idea. It wouldn’t be wise to refinance (and get into more debt) because you’d like a new car, want to remodel your kitchen, or plan to pay off credit card bills. Wiping out your home equity to buy new stuff you don’t need puts your home at risk—especially if you lose your job or encounter other financial difficulties.
And if you’re currently out of work because of the coronavirus and finding it difficult to pay your mortgage, there’s good news for you. Depending on your specific situation, you may be able to have your mortgage payments lowered or put on hold for the next 12 months.5 That can really help to free up the burden you might be feeling right now if you’re concerned about when you’ll see your next paycheck.
Ready To Refinance?
Refinancing your mortgage is worth it if you’re planning to stay in your home for a long while. That’s when the lower interest rates you want to take advantage of really start to pay off!
If you’re ready to refinance, get with the home loan specialists at Churchill Mortgage. They’ll help you get a mortgage you won’t regret!