With mortgage rates at unprecedented lows, and benchmark bond yields dropping below 1 percent for the first time in history, conditions could be ripe for first-time homebuyers and those looking to refinance. But how do you know if the time is right to take advantage of the savings a less expensive interest rate could bring? Here are five questions homeowners should ask themselves before they pursue a mortgage refinance.
1. How long will I stay in this home?
Mortgages are paid out over the span of many years, with most of your payments going toward the interest rather than the principal owed on the loan during the initial period. This means time is one of the most significant factors in determining whether a refinance makes financial sense. Homeowners who are planning to move to a new house in the next five or so years may actually save more by remaining with their existing mortgage rather than refinancing, given the fees you’ll have to pay your lender.
People who are in their forever homes, meanwhile, could benefit from taking out a 15-year loan rather than a 30-year loan. The average interest rate on the 15-year fixed-rate mortgage is typically lower than the 30-year loan (currently standing at 2.79 percent). So, while these loans require larger monthly payments, the aggregate savings are greater. A 15-year loan also would allow the homeowner to build equity faster, which they could then tap through a home-equity loan further down the road if unexpected expenses arise.
2. How much will I save?
To save money with a refinance, the general rule of thumb is that the new interest rate needs to be 50 basis points lower than your current one. When looking at the average rates reported by Freddie Mac, however, it’s important to note that the rates offered by your lender can be even better. Lenders also can adjust how much you spend in closing costs. Another factor that can shift overall savings is the discount points—these are fees lenders collect at closing to reduce the long-term interest rate. If you can pay more at closing, this could bring your interest rate down even more.
3. Am I paying mortgage insurance?
Borrowers are required to pay mortgage insurance if they get a Federal Housing Administration (FHA) loan, or if they get a conventional loan with a down payment of less than 20 percent. So, when refinancing, it’s critical to review what type of loan you can get and how much equity you have. Getting rid of the mortgage insurance will boost your overall savings and can make a refinance worth it even if you’re outside the 50-basis-point threshold. If you haven’t built up much equity in your home through your monthly mortgage payments, but have a large amount of cash in savings, a cash-in refinance can help push you above the 20-percent mark.
4. Is my financial house in order?
Mortgage refinance applications can be denied because the borrower’s debt-to-income ratio is too high, followed by having poor credit. Taking steps to improve both your debt-to-income ratio and your credit score ahead of applying for a new home loan will increase the odds of getting improved. Anything you can do to reduce your non-mortgage debts will help, and it’s also a good idea to verify that there are no errors on your credit report. Another reason to review your credit history: Your score has likely improved as you’ve been paying off your mortgage.
5. Will refinancing with my existing lender be beneficial?
Because your existing lender already has your personal information and payment history, refinancing with them can often be an easier process. Refinancing with your existing lender can mean better savings by amortizing the new loan. Your lender will have a sense of how long you’ve had your existing loan, and as a borrower, you’ll save more by refinancing to a shorter duration than getting a new 30- or 15-year loan and starting from square one.