If you’ve been tracking mortgage rates in recent weeks, you know that interest rates are higher than they were a month or so ago. While some homeowners may feel their refinancing window has closed, mortgage rates remain historically low and there are still many reasons a refinance may provide you with financial benefits.
Before you can decide if this is the right time for you to refinance, you need to determine why you want to replace your current mortgage. For some borrowers, the idea of getting a lower interest rate is enticing all by itself. However, no refinance is entirely free. You’ll be taking out a new loan so you’ll typically need to pay for an appraisal as well as closing costs.
An important element to your decision is how long you intend to stay in your home. If you plan on moving within a year or two, you may not recoup the cost of refinancing before you sell your home.
Most homeowners choose to refinance either to reduce their monthly mortgage payments or to shorten their loan term. If you’re concerned about cash flow, refinancing into a new 30-year fixed-rate loan can help, but remember you may end up paying more in interest in the long run because you’re extending your loan term.
Interest rates on shorter term loans, such as 10, 15 or 20-year loans, are lower than mortgage rates on 30-year loans. Your payments will likely rise with these loans, though, since you’re compressing the amount of time you’ll take to pay off your loan in full.
A refinance calculator like the one at HSH.com (www.hsh.com/usnrcalc.html) can help you decide whether refinancing is a smart choice for you.
Meeting with a lender to discuss your refinance is free, so you should take advantage of a free consultation to decide whether mortgage refinancing is right for you.
Mortgage lenders review two factors when deciding whether to approve a refinance: your creditworthiness and your home value. Even if you’ve consistently paid your mortgage on time for years and your payments with a new loan will be lower, you’ll need to complete an entire new loan application and will need to provide documentation for your income, assets, debt and job history. Generally, mortgage lenders look for a credit score above 640 or higher to approve a new loan, but the best mortgage rates are available to borrowers with a credit score of 740 or higher. In addition, your overall debt-to-income ratio (gross monthly income compared to minimum payments on all debt) should be a maximum of 43 percent. Some lenders may go as high as 45 percent, depending on other factors.
Your home will also need an appraisal. To get a ballpark idea of your home value before you apply for a loan you can contact a Realtor or compare recent sales of similar homes in your community. Some lenders are willing to refinance a home with a loan-to-value of 90 percent, while others will only refinance loans with a loan-to-value of 80 or 85 percent. Keep in mind that if your loan-to-value is more than 80 percent, you’ll have to pay private mortgage insurance (PMI) even if you aren’t paying it now.
An FHA refinance is an option for homeowners with three percent or more in home equity, but you’ll be required to pay mortgage insurance for the entire loan, which will increase the size of your housing payments.
Closing cost choices
Some lenders offer “no-cost” refinancing, which means that you don’t have to pay out-of-pocket expenses for your closing costs on your new loan. Your lender pays all the fees. However, these loans generally have a slightly higher interest rate than a loan with closing costs. For many borrowers, the higher rate can still be worthwhile as long as it’s lower than your current interest rate.
Another option many borrowers choose is to add their closing costs to the balance of their mortgage. A quick calculation can tell you when you’ll reach the breakeven point and begin actual savings. For instance, if you pay $2000 in closing costs and you’re saving $100 per month on your mortgage, it will take 20 months before you’ve repaid the closing costs.
A third option is to pay your closing costs in cash. If you opt to do this, just make sure you’ve got sufficient cash reserves for an emergency fund.
The federal government’s Home Affordable Refinance Program (HARP), designed to allow homeowners to refinance even if their home value has dropped, has been extended through 2015. Find out if you’re eligible here: www.makinghomeaffordable.gov
Refinance and renovate
If you want to update your kitchen, add a family room or an attic or replace your furnace, you may want to look into the FHA 203(k) loan program or the Fannie Mae HomeStyle Renovation loan. A lender can delve into the details of these programs for your individual needs, but both allow you to combine your renovation costs with a refinance. Your loan amount is based on the estimated value of your home after the renovation. The benefit of these programs is that you can finance your remodeling costs within your first mortgage at today’s low interest rates.
Mortgage refinancing isn’t always the right answer for every financial need, but a free consultation with a lender and a discussion with your financial advisor can help you decide if a new home loan can help you reach your financial goals.