If you took out a mortgage as recently as a year or two ago, there’s a good chance you were cracking open a Budweiser to celebrate your incredible interest rate.
Fast forward to today, and home loans are even cheaper. As of this writing, average rates on a 30-year mortgage are in the sub-3% range, something that seemed unthinkable even a decade ago. If you’re like a lot of homeowners, that may leave you wondering: Should I refinance my mortgage now?
While trading in your existing home loan for one with lower interest may seem like an easy call, experts say that, much like those robots in disguise, there’s more to mortgage refinancing than meets the eye. Because you have to pay substantial costs whenever you do a refi, you have to look at whether the lower monthly payment makes up for it in the long run. That’s not true in every case. Here’s what you need to know.
To Refinance Mortgage or Not to Refinance Mortgage?
That is indeed the question. Refinancing right now is likely to put you into a loan with lower rates, especially if your FICO score is in good or excellent territory. But, alas, many of the same closing costs you paid for your original mortgage creep up again when you refinance.
Among the outlays you’ll likely encounter: a loan origination fee that covers the cost of underwriting and processing the mortgage, a fee for the title services ,and a charge for an updated appraisal of the property. Depending on your loan, you may be forking over prepaid interest, or “points,” to boot.
According to the mortgage giant Freddie Mac, average closing costs run about $5,000 nationwide. Those figures can vary quite a bit based on the amount of the loan and other factors, but in most cases they’re hefty enough to make an impact on your decision.
So when does it make sense to take advantage of lower mortgage rates, exactly? Unfortunately for the math-disinclined, that requires doing a little algebra to figure out whether the reduction in your mortgage payment meets or exceeds whatever costs you incur upfront. The bottom line: You should plan on staying in your home for at least as long as it takes to break even on your closing fees.
“A refinance is more advantageous the greater the spread between the number of years it takes to break even compared to the number of years that the homeowner expects to live in the home,” says Marla Chambers a senior financial planner with Buckingham Advisors in Dayton, Ohio.
Take, for example, a mortgage that’s due to be paid off in 15 years at $2,000 per month (excluding escrow) that can be refinanced into a new 15-year loan at $1,800 a month. The breakeven would be 16 months if the closing costs totaled $3,200.
One of the mistakes borrowers often make, however, is comparing monthly loan payments on mortgages with different terms. If you only have 10 years left on your current loan and refinance into a 30-year mortgage that spreads out your payments by 20 extra years, your breakeven point is going to seem quicker than it actually is.
For that reason, Chambers recommends calculating the monthly payment for the refi interest rate using the same number of months as your current loan, even if the payoff date is actually going to be later. That way, you’re getting a true apples-to-apples comparison.
Cashing Out Your Equity
Of course, getting a lower interest rate isn’t the only reason you may be thinking about redoing your mortgage. Homeowners may decide that they want a different loan duration – for example, replacing a 30-year mortgage with a 15-year loan. Or they may prefer a different type of loan, like swapping out an adjustable-rate product with one that’s fixed.
Another popular option: Performing a cash-out refinance, where you take out a new, bigger loan in order to get your hands on some extra greenbacks. While using your home as an ATM might seem like an easy decision when rates are this enticing, you may be looking at a higher monthly payment afterward that could get in the way of other financial goals.
Wesley Stien, a fee-based planner in Arlington, Virginia, warns it’s not just the couple taking that money to their nearest Mercedes dealership who can fall into a trap – it’s also the well-intentioned borrower who uses it to pay down credit card debt only to rack up new balances. “They haven’t addressed the underlying issue,” he says.
Rather than tapping your equity on a one-off basis, Stien recommends weaving your refi into an overall strategy that gets you closer to your long-term financial goals. If you don’t have a plan to stay out of debt, converting equity to cash is a dangerous game.
Some Mortgage Refinance Tips to Keep in Mind
Applying for a mortgage refinance isn’t something you’re going to want to jump into head first, at least if you want to snag the best deal possible. To do that, you’ll need to have a game plan.
One of the keys here is getting your timing right. Chambers suggests working on a refi before you switch jobs, for example, so you can demonstrate a steady work history and put lenders at ease about your ability to pay them back.
She also advocates getting your credit score in top form, something that can take weeks, or even months, of groundwork. Before you apply for a loan, look over your credit reports from the three bureaus – TransUnion, Equifax and Experian – and address any negative information that might have landed there by mistake.
You’ll also want to home in on areas that FICO tends to weigh heavily. “Work on increasing your score prior to applying for a mortgage by paying down credit card balances and making timely monthly debt payments,” says Chambers.
As with any big purchase – and they don’t get much bigger than a new mortgage – one of the keys is shopping around. Stien suggests contacting at least two lenders, whether they’re big-name mortgage companies or local credit unions, to make sure you’re getting the best deal.
Websites like LendingTree represent a quick way to analyze multiple loan offers, although Stien suggests a less likely place for some comparison-shopping: Costco. Yep, that Costco. The wholesaler’s mortgage-shopping service limits closing costs for its members – they won’t exceed $250 for those at the Executive level or $550 for Gold Star members. This is no time to leave any stones unturned.
Any reputable lender will provide you with a three-page Loan Estimate that outlines pretty much all the key stuff you need to know, like the interest rate, the monthly payment, a full list of closing costs you’ll have to pay and any points they want you to put down.
Keep in mind that one lender may have a lower rate, but higher closing costs compared to another offer. You’ll want to take all those things into consideration when figuring out which one represents the better deal in the long run, says Stien.
While you’ll pay the same amount in property taxes regardless of which bank you choose, there’s nothing set in stone when it comes to line-items like the origination fee, which the lender usually shares as a percentage of the loan amount. If any of the fees look out of whack compared to the others, it might be time to brush up on your negotiating skills. You may just save yourself a few bucks in the process.