Is a Mortgage Refinance the Best Option
How To Know If a Mortgage Refinance Is Your Best Option?
When interest rates are low, applications for a mortgage refinance are a major portion of the total of all mortgage applications. This is due because when mortgage interest rates fall, many borrowers see an opportunity to restructure their debt hoping to get a more favorable rate or term.
Simply having a drop in mortgage interest rates doesn’t mean that its the right thing to do for everyone. We all have different situations and lifestyles and everyone doesn’t fit into the “average” cookie cutter mold. Because of this, the following 9 points may help you if you are considering refinancing your mortgage.
The equity in your home
Equity is one of the first items that a refinance lender will look at. If it’s not there within the banks’ guidelines, most conventional lenders will decline your request. During the last recession, many homeowners were underwater, some very deep.
The value of homes has been rising as of late and the number of underwater loans has dropped. This varies from state to state and is determined by a number of factors. If your home has little equity, a conventional lender probably won’t look at it, but there are some federal government programs that may be available to you.
Anyone applying for a mortgage refinance will have an easier time of it if they have equity in their home of at least 20%.
Your credit score
After the last recession, lenders tightened credit requirements for all types of loans and especially mortgages. Some homeowners who have a decent score are surprised to discover that even that won’t always qualify for the lenders best rate.
In today’s market, many lenders are looking for a credit score of 750 or better to get their best rate. If your score is a little lower, you’ll most likely be approved, but your rate will be higher and the amount of fees may also be higher.
- Ratio of debt to income
This is one of the ratios that lenders now watch more closely. Borrowers that have mortgages already on the books are often surprised when they apply for a new loan. Banks look closely at this ratio plus job history and high income.
Another ratio that a lender will look at is to make sure that your monthly payment is 28% or less of your gross monthly income. The total debt to income ratio should not exceed 36%. This may vary slightly between lenders but it is watched closely.
Costs for refinancing
Usually, when you do a mortgage refinance, the costs average about 3% to 5% of the amount of your loan. However, there are ways to reduce these costs if you have a high credit score and your other ratios are excellent.
If there is ample equity in your home, you may be able to add the closing costs to the loan principal. Whenever you see lenders advertise a “no cost” refinance, they are doing that. You’ll probably pay a higher rate of interest as well. So, negotiate these items and by all means, shop around.
Rates and terms
You need to establish your goals before you apply for a refinance of your mortgage so that you will get the deal that works best for you. As an example, if you want to get the lowest monthly payment possible, then look for the lowest interest rate and the longest term.
If you want to reduce the total interest paid over the life of the loan then you need to look for the lowest rate of interest and the shortest term. If your goal is to get rid of your loan as quickly as possible, then again look for a low rate loan with the shortest term that requires monthly payments that you can afford.
Points on a refinance
As you review the different refinance offers, look carefully at the rate of interest and any points charged. Lenders sometimes charge points in order to offer you a lower interest rate. Also, some will finance the points, so calculate this area carefully and weigh your options.
Your break-even point
You need to make this very important calculation before a mortgage refinance is done. This is defined as the point where your aggregate monthly savings equals the total cost of the refinance. As an example, say that your savings each month are 100.00 and the total cost of your refinance is 2,000.00. In 20 months, you would hit the break-even point and recoup the costs.
This might make sense under normal circumstances, but if you are planning to move in two years, a refinance might not be a good option for you.
Private Mortgage Insurance Cost
If you’re contemplating a mortgage refinance, and you don’t have at least 20% equity, another cost will be added known as Private Mortgage Insurance (PMI). If you’re paying this on your existing loan, it might not be a big deal to you.
A homeowner whose home has decreased in value, thereby reducing the equity, will not be happy to see that they now have to pay PMI. As an example, say the amount refinanced is 150,000.00 and the PMI rate is 1%. This equates to 1,500.00 per year and adds 125.00 to the monthly payment.
If you’re trying to get a lower monthly payment with a lower rate of interest, adding the PMI in may just make the transaction not doable. Your lender can tell you fairly quickly if you will have to pay PMI and the impact that it will have.
Income taxes
A lot of homeowners rely on mortgage interest as a deduction on their tax return to lower their tax liability. I personally don’t look at that as a benefit in keeping a mortgage. I planned on being debt free and achieved it many years ago. Paying a lender interest is cash out of your pocket. besides that, the new tax code has changed this.
The Tax Cuts and Jobs Act made changes to the tax year 2018 that may have a direct bearing on whether you will deduct mortgage interest. The new and increased standard deduction which is 24,000.00 for a married couple filing jointly, may preclude you from itemizing.
Homeowners who have large mortgage debt will probably continue to itemize, but they may be affected by the cap on the taxes section of Schedule A, which is 10,000.00. If you’re factoring in income taxes for your calculation to see whether to refinance, you might want to consult with a tax adviser.
Mortgage refinancing like, most financial transactions, can be very complex and if you aren’t sure what you need to look out for, we urge you to get competent help. Make a list of all questions that you have, and gather as much of your information available, and meet with a reputable lender.
The lender will be able to help you to understand if a mortgage refinance is the right option for you.
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12 responses to “Is a Mortgage Refinance the Best Option”
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I really like this website. I signed up to be notified each time you publish a post, and I’m so glad that I did. You have so many posts that apply to what I’m looking for. This one above has so much valuable information and can save you a lot of money. Thanks so much for your time and work in providing this free information.
Thanks for your comment Howard and glad that our articles are helpful. We’ll do our best to keep them coming.
With the new tax law applicable for 2018 taxes, I’m wondering if we will get stung on our taxes if we refinance our existing mortgage. We took out our current mortgage a number of years ago and with the current rates today, we can drop at least 2% and shorten our term as well. Our balance is around $900,000.
Thanks for your question Wesley. It appears that your loan may be grandfathered at the $1,000,000 cap and not the new $750,000. However, if you do a refinance, make sure that you don’t increase the outstanding balance. Don’t even finance the settlement costs or any fees.
This is a very interesting article, thanks! Your areas to consider make it easy for someone who is contemplating a mortgage refinance. It will also reduce stress for many.
Thanks for your kind words Tony, it’s much appreciated.
My husband and I have refinanced a mortgage several times over the years and did so only when it made good sense. Your post on what to look out for would have helped us a lot in the past. By the way, it’s hard to believe that many years ago we thought our 7% mortgage rate was a fantastic deal.
Hi Nora. I can recall many years ago, when an interest rate above 7% or 8% was low.
Just wanted to say thanks for the great information. I’ve used a 0.5% drop in the interest rate as a time to refinance and shopping around for the best deal is crucial. I’ve heard that years ago if your rate reduction wasn’t 1.5% to 2%, you shouldn’t do it.
Hi Gregory. Yes, many years back settlement cost and fees charged on a refinance were a lot higher and so a larger spread was required to make it worthwhile.
In your article where you speak of a “break even” point, are you referring to recovering the cost of your refinance through the savings on your new loan? Or do you mean something else that I’m not aware of? Great article.
Hi Martha. Yes, we basically define your break even point to be a point where your aggregate monthly savings is equal to the total cost of your refinance. Say your monthly savings are $100.00 and the total cost of the refinance is $2,000.00. It would then take 20 months for you to recoup the total cost, and this would be your break even point. Remember though, if you were planning to move in a couple of years, it might not be worthwhile. If you planned to stay there for the long term, then it would.