Got a high mortgage rate? You may want to consider refinancing.
Refinancing currently accounts for about 32% of all mortgage applications, depending on the interest rate at the time (by comparison, in 2016, when rates were relatively low, refinancing accounted for almost half of all applications).
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Refinancing — the process of taking out a new loan to replace your current loan — is done for many reasons, said Brie Sodano, a personal finance expert based in Connecticut. Here are some of the most common motivations:
Lowering a mortgage rate
This usually will reduce your monthly payment and cost of interest overall, Sodano said. If mortgage rates have significantly dropped, then it’s a good time to refinance. You could save a meaningful amount of money over a period of 15 or 30 years this way. Use this mortgage calculator to see how much you can save by refinancing to a lower rate.
Tapping into home equity
“Some people use their home’s equity to pay off debt or to make renovations to the house,” Sodano said. Adam Mitchell, owner of We Buy Houses Fast, in Dallas, said he refinances properties to cash out equity from time to time in order to reinvest in additional properties. “We recently refinanced two rental properties, pulled out $100,000 in equity and are looking to invest that into new properties now,” Mitchell said. “Even though the rates on the refinanced loans are a little higher, the return on the new money invested in new properties will far outweigh slightly higher rates.”
Changing a loan term
Go from a 30-year loan to a 15-year loan — or simply choose a term that matches your expected need for the money, said Bruce Ailion, realtor and attorney with Re/Max Town and Country in Atlanta. “When you buy money for 30 years, you are paying more than if you buy it for seven to 10, often a lot more,” Ailion said. “Looking at all ages and all buyers — 50% have moved by year 15.”
Convert ARM to fixed
With an adjustable rate mortgage (ARM), the interest rate may rise or decline. After a low initial rate, ARMs tend to rise — especially today, as interest rates are heading upward (during the last week of April 2018, for example, typical interest rates were up nearly a full point from seven months prior).
Convert FHA to conventional
An FHA loan (a federally approved loan insured by the Federal Housing Administration) requires a down payment of 3.5% but is only available for homeowners whose home is their principal residence. For an FHA loan, you have to pay 1.75% in mortgage insurance premium when closing, and you must make monthly mortgage insurance payments if the down payment of the loan amounts to less than 10%. An FHA mortgage doesn’t carry prepayment penalties, so you can pay it off early and switch easily, refinancing with any lender who accepts you. A conventional loan typically has a higher minimum down payment, but you don’t have to pay insurance if your loan-to-value (LTV) ratio is 80%.
Before you refinance, you should be aware of the costs associated with doing so: Plan to spend an additional 2 to 3% of the amount you borrow for closing costs.
- Application fee $75-$300
- Appraisal charges $350-$800
- Origination fees 1-1.5% of principal
- Document prep fees $200-$500
- Title search fee $700-$900
- Recording fees $25-$500
- Inspection charge $300-$850
- No-cost refinance. Yes, this is a possibility — but there’s no such thing as free money. If a lender is offering a no-cost refinance, they’re most likely either charging a higher interest rate (possibly one interest rate plus fees, or a higher rate without fees) or adding the closing costs to the loan.
How to lower mortgage refinance costs
A study by the Consumer Financial Protection Bureau (CFPB) found that 47% of buyers didn’t seriously consider more than one lender, and 77% of buyers only applied to one. But if they had shopped around, they would have saved a significant amount of money. A 4% interest rate on a $200,000, 30-year fixed mortgage will save you $60 per month and $3,500 in the first five years compared to an interest rate of 4.5%, the study found.
Another study, by LendingTree, found that the median spread between APR quotes for individual borrowers for each loan request was six-tenths of a percentage point in March 2018, up by more than one-tenth of a percentage point from the same time the previous year. That means if you present the same information to each competing lender, you’d most likely see a spread of about six-tenths of a percentage point in quoted APR. So for a $300,000, 30-year fixed-rate mortgage, that would equate to a $26,780 difference.
When you shop around, you shouldn’t only focus on the interest rate, said the CFPB. When comparing loans, you should examine:
- The upfront costs
- The lender credits
- The amount of cash you’ll need to close.
- Your total monthly costs, which include principal, interest, mortgage insurance, property taxes, homeowners’ insurance and homeowners association dues.
- The total loan amount
Mortgage fees and rates can always be negotiated, and it helps to ask the right questions, according to the CFPB. Make sure you ask about each fee and whether there’s room for negotiation within each one (some may waive the processing or underwriting fees, for example). You could also see if you could pay more toward the closing costs in exchange for a lower mortgage rate, or vice versa. However, because the government charges taxes, recording fees and city and county stamp fees, it’s not likely that you’ll be able to negotiate these costs. The lender also typically pays a set price for the appraisal, the credit report, the tax service fee and the flood certification fee, so these may also be more difficult to negotiate.
Getting a zero-closing-cost loan
This is possible (see above), but be sure to ask many questions, as these types of loans typically come with higher closing fees or interest rates. The pros of a zero-closing-cost loan is that you can refinance now and potentially begin the interest savings sooner, Sodano said. But the cons are that the closing costs are typically added to the back end of the mortgage, and you pay interest on them until the mortgage is paid off.
Does it make sense to refinance in a rising interest rate environment?
Mortgage rates are relatively high today compared with the last few years, so for that reason, you may want to think twice about refinancing. But Sodano said it could still be a good idea. “Many people have mortgages that are 10, 15 years old, and their rates could be higher than they are now,” she said. “There are a lot of reasons why someone would refinance — the rate is just one of many considerations.”