interest rates

Now Is a Good Time to Refinance

You may benefit even if you can’t reduce your mortgage rate by a full percentage point.

Mortgage rates have dropped to levels not seen since 2016, and homeowners are rushing to refinance. You can benefit even if you don’t cut your rate by a full percentage point—a rule of thumb you can safely ignore. The question is whether you will stay in your home long enough to recoup the closing costs with savings on your monthly payments. For a quick answer, run the numbers using the refi break-even calculator at Bankrate.com.

Borrowers who closed on their loans in 2018 are leading the charge, according to Black Knight, a mortgage data, analytics and software provider. Say you got a $300,000 mortgage with a 30-year fixed rate of 4.5% last fall. If you refi to a rate of 3.8%—the national average rate reported by Freddie Mac in mid July—you would cut your monthly payment of principal and interest by $145, to $1,375, and you’d pay for your total closing costs (estimated at 2% of the loan balance) with monthly savings in 41 months.

Borrowers with adjustable-rate mortgages (ARMs) are refinancing to fixed rates in the highest numbers since 2007, presumably to lock in a low rate they’ll never need to think about again. In mid July, the average rate for a 5/1 ARM (the interest rate is fixed for the first five years and adjusts annually after that) was 3.5%, and for a 7/1 ARM, the rate was 4%, according to Bankrate.com.

If you originally took out an FHA loan but have since improved your financial profile or accumulated 20% equity, you can refi into a loan backed by Fannie Mae or Freddie Mac and not only reduce your interest rate but also eliminate the cost of mortgage insurance, which applies permanently on most FHA loans.

If you want to build equity more quickly or pay off your mortgage sooner—say, in anticipation of retirement—you could refinance into another, cheaper 30-year mortgage and use the monthly savings to prepay your mortgage. Or, if you can handle a higher monthly payment, you could take a new mortgage with a shorter term of, say, 15 or 20 years. In mid July, the average 15-year rate was 3.2%.

Gather your information. You can find an estimate of the market value of your home at Zillow.com or Trulia.com. Or ask a real estate agent, who may get your business down the road, to provide a market valuation of your home based on recent comparable sales.

Next, check your credit. The stronger your qualifications (the more equity you have, the higher your credit score and the less debt you carry), the lower the interest rate you’ll be able to get. Rates will be higher if you take cash out, take out a super-conforming mortgage (with a loan balance of $484,351 to $726,525), or are refinancing a multi-unit or investment property.

Well before you shop, double-check your credit reports from Equifax, Experian and TransUnion, the three major credit-reporting agencies (free annually at annualcreditreport.com) to ensure that no errors drag down your score. You may be able to check your credit score for free on the website of your credit card issuer, and everyone can see their credit score at Discover.com. (See 6 Ways to Boost Your Credit Score—Fast.)

Shop a variety of lenders, including the originator of your existing loan; your current loan servicer, bank or credit union; Quicken Loans; or a mortgage broker who may be able to pass along wholesale rates to you (look for an independent broker at findamortgagebroker.com). If you need a jumbo mortgage and are a client with your bank’s wealth advisory group, it may offer you the best deal, says Adam Smith, a mortgage broker in Denver. (The average jumbo rate in mid July was 4.1%, according to Bankrate.com.)

When you’re shopping for a mortgage, multiple credit checks won’t diminish your credit score if they occur within 30 days prior to calculating your score. And in the newest versions of the FICO score, those multiple inquiries made within a 45-day period count as only one inquiry.

Lenders will typically charge you from 1% to 3% of the loan balance to refinance. Closing costs will include the lender’s origination fee, third-party costs (including the cost of an appraisal, title search and so on) and recording costs.

You could pay the closing costs out of pocket. But before you do, consider how you could deploy the money for a better return. If you have enough equity, you can add the closing costs to your loan balance and finance them. With rates so low, the impact on your monthly mortgage payment could be negligible. But a higher loan balance and loan-to-value ratio could tip you into a higher risk category with a higher interest rate.

Or you could pay a higher interest rate in exchange for a lender credit that offsets closing costs. You can use the Tri-Refi Calculator at HSH.com to estimate the difference in outcome, but your loan officer should help you make the right decision to maximize the benefit of the refi.

Once the refinancing is under way, don’t open new credit lines or increase the balances of your existing credit because lenders will reverify your debt-to-income ratios just before closing. If the ratios exceed the lender’s limit, it must requalify you.

Prove it. Before a lender can approve your loan, it must document and verify your employment, income, assets and more. But lenders are trying to streamline the process, from application to closing, with technology. For example, at Quicken, customers can import their account statements directly from their bank or brokerage.

You will need an appraisal of your home’s value. Your lender may accept an automated valuation. But if it can’t access enough data or you’re taking cash out, the lender probably will send an appraiser to visit your home.

Cashing out

Homeowners have amassed nearly as much home equity as they had before the housing bust, but they have been cautious about extracting it. Although Fannie Mae and Freddie Mac will let you borrow up to 80% of your home’s value, and FHA will let you go up to 95% if you’ve made your payments on time for 12 months (85% otherwise), most borrowers are being more conservative, borrowing only 65% to 70% of their home’s value on average, says Bill Banfield, an executive vice president at Quicken Loans.

Freddie Mac says that homeowners who are tapping their home equity through cash-out refinancing are using the money to pay off more-expensive debt, make repairs or improve their homes, add to their savings, buy a car or other major purchase, or save or pay for college expenses.

Under the new tax law, if you don’t use the money to substantially improve your home, the interest on that portion of the loan isn’t deductible if you itemize.

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