How to know if it is time for you to refinance?
As mortgage rates keep plunging to new lows, homeowners are seizing on opportunities to reduce their monthly payments and total interest costs.
The unprecedented rate drop has doubled the number of mortgage refinance applications compared to a year ago. When you refinance, you get a new home loan with new terms, and you pay off your existing mortgage.
Whether you should refi right now comes down to whether you’ll ultimately save money in the deal — and how the transaction might be affected by the coronavirus pandemic, which has helped push rates lower but made lenders more wary.
Tim Lucas, editor with The Mortgage Reports, says you probably don’t want to wait.
“Rates could go lower in August 2020 and beyond, but why would someone gamble when they could capture a best-ever rate right now?” he writes.
Are you a good candidate to refinance? Here are six things to help you decide.
1. Your interest rate
Pretty much every homeowner is hunting for a rock-bottom rate. Thirty-year mortgage rates have been dipping below 3% for the first time ever as the Federal Reserve has taken extreme measures to cut interest rates and bring the economy out of its coronavirus recession.
Some mortgage experts say refinancing isn’t worth the time and money involved unless you can slash your rate by at least around three-quarters of 1 percentage point. That means, for example, if you can go from 4% down to 3.25% or lower.
More than 16 million homeowners could potentially lower their rate by three-quarters of a point or more — and save an average $283 a month, says mortgage data firm Black Knight.
Shop around and compare rates from several lenders to find the best rate available to you.
2. Your break-even point
When you get a rate quote from a lender, you should receive an estimate of your new monthly payment and closing costs. Those loan fees typically reach $5,749, according to mortgage data firm ClosingCorp.
“Borrowers should consider how long it will take to break even on the refinance by dividing those new hard costs (if any) by the monthly payment savings,” says Matthew Graham, chief operating officer of Mortgage News Daily.
When you do the math, you’ll see that if you spend $5,749 to save $283 a month, you’ll break even within 20 months. It might not make sense to refinance if you may be moving out of the home relatively soon.
Also consider how long you’ll be paying interest. If you’re 10 years into a mortgage when you refinance into a new 30-year loan, then you’ll be making 40 years’ worth of payments in the long run. In that case, you might want to explore refinancing into a 15-year loan or a 20-year mortgage, instead of going with another 30-year.
3. Your job security
Lenders recheck your employment status right before you close on a refi loan. In recent months, many people have found themselves out of work and out of the running for a new mortgage because of COVID-19 lockdowns.
If you’ve lost your job, your company has shut down or your manager is out of reach due to the virus, the loan could fall through.
Try to head off problems by coordinating with your manager beforehand. And if you think your job may be in danger, keep up your networking and take other steps to protect your finances and find a new job quickly.
4. Your credit score and DTI ratio
Today’s high unemployment raises risks for mortgage lenders, who are demanding higher credit scores and tightening other lending standards to protect themselves.
The average FICO credit score for conventional loan refinance applicants was 762 in May, up from 741 a year earlier, according to mortgage software firm Ellie Mae. If you haven’t looked at your score in a while, you can easily check it for free.
Lenders also look more closely at a borrower’s debt-to-income ratio, or DTI, which measures what portion of monthly income goes toward debt payments. A lower ratio means less risk for the lender.
A year ago, lenders were approving borrowers with debt-to-income around 36%. Requirements were stricter in May, when the average borrower had a DTI of 33%.
If your credit score has dropped recently or you’ve taken on more debt, you might not qualify for a refinance. You’ll need to check with your lender about requirements.
5. Your overall budget
A refi could help lower your monthly payment and create breathing room in your budget. But consider all of your financial goals.
Do you have money earmarked for financial emergencies? It might be better to keep money stashed in savings rather than use it toward closing costs.
And don’t go raiding your retirement account to pay for a refinance either. If you have your retirement savings in a 401(k) plan through your job or a traditional IRA and you’re younger than age 59 1/2, you’ll have to pay income tax on the withdrawal plus a steep penalty equal to 10% of the amount you take out.
6. Your home equity
When calculating your refinance costs, your lender will check your home equity. That’s how much of your home you own, based on the difference between your mortgage balance and the home’s market value.
Having more equity can increase your loan-approval chances (you’ll need at least 20% for conventional loans) and help you get a lower mortgage rate on your refinance.
Refinancing a mortgage is a personal decision. It’s a great way to cut costs and make room in your monthly budget. Just be certain you’ve got the stuff to qualify for the loan and that you’ll stay in the home long enough to actually save money.
We would love to walk you through the various refinance options available to you and help you decide if a refinance makes sense for your unique situation. Call us at 951-239-9403 or email tyler@letsdohomeloans.com to set up a free virtual consultation.