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When to Refinance Your Mortgage
Despite the economic hardships people are facing around the country, this year has been a popular time to refinance or borrow money to purchase a home. Even people with relatively new mortgages are cashing in on all-time low interest rates thanks to record-low mortgage interest rates.
Right now, it’s common to see rates hovering near 3% on 30-year mortgages. Those low rates are due, in part, to the economic hit the nation took from the COVID-19 pandemic. But it’s not just the 30-year mortgage rates that are low right now. Rates on 15- and 20-year mortgages have also plunged to record lows in recent months.
Still, these low refinance rates aren’t always the rates you’ll get when you apply. Your actual rate will depend on your credit score, employment history and overall financial picture, along with the equity you’ve built in your home and other factors.
If you’re on the fence about whether this is a good time to refinance your mortgage, you may want to look at the benefits and drawbacks of a new loan. That will help to determine whether refinancing your mortgage makes sense for you.
What is a mortgage refinance?
When you refinance your mortgage, you pay off your old loan with a new loan that has a new interest rate or a different mortgage term. Your payments and mortgage terms follow the new loan, and the old loan is no longer a part of the equation.
You might also refinance your mortgage to tap into the equity in your home to pay for home improvements or other large expenses, such as paying off student loans or getting a car loan.
If you want to lower your monthly payments, this is a good time to take advantage of historically low interest rates. Maybe you have a 30-year loan and want to shorten the term of your loan to a 15- or 20-year loan. Or you may want to switch from a fixed-rate mortgage to an adjustable-rate mortgage to cut your interest rate down.
You could also choose to refinance because you’ve built up 20% equity in your home and want to free yourself of private mortgage insurance by refinancing.
The process of refinancing your mortgage is similar to when you first took out your original mortgage. You will fill out an application and submit the documentation requested by your lender. You can work with a bank, credit union or refinance your mortgage with a mortgage lender. The process of refinancing takes less than a month on average, but it can be longer if issues arise.
When it’s a good time to refinance your mortgage
Figuring out when to refinance can seem like a puzzle if this is the first time you’ve considered it. Luckily, there are a lot of factors you can weigh to decide if the time is right. These factors include the current interest rates, your credit score, the value of your home, your financial profile, your financial goals and the current economic climate. If a few of these factors are more favorable than when you initially bought your home, refinancing could be a great move.
Situations where refinancing makes sense include:
- Your credit score or financial profile has dramatically improved.
- Mortgage interest rates have dropped significantly from when you purchased your home.
- You want to cash in on some of the equity you’ve built up in your home.
- You need to find a way to lower your monthly payments.
So, how does refinancing work?
Refinancing is a fancy financial term that just means taking out a new loan to pay off your old loan. By doing this, you may be able to lower your monthly payments or save significantly on your total interest costs over the life of the loan.
Additionally, you have the opportunity to change the type of loan you have. Refinancing options available are similar to those with a new home purchase and include options like fixed-rate loans, adjustable-rate mortgage (ARM) loans, cash-out refinance loans, rate-and-term loans, VA loans, USDA loans and cash-out refinance loans.
Determining when you should refi starts with a look at your financial goals, the type of loan you’re looking for, your financial situation and the current market climate.
How to refinance a mortgage
- Decide why you want to refinance your mortgage. Are you refinancing your loan to shorten your term, reduce your interest rate, go from a FHA or VA loan to a conventional loan or for another reason? Make sure you know why you’re refinancing before you do it.
- Make sure your credit score is in order. You won’t get the best rate for your refi if you have credit issues, so make sure you don’t have any credit blips you weren’t aware of. If you do, take the time to get them resolved or clean up your credit before applying.
- Shop rates. Check with your bank, credit union or a mortgage-specific lender for the best rates. Be sure to take closing costs and fees into consideration.
- Go through the application process. Apply for your mortgage, keeping in mind that your credit score will take a temporary hit.
- Lock in your interest rate. Be sure to do everything you can to close the loan before the rate lock expires.
- Close on your loan. Remember it may take a month or more before your loan is finalized. At closing, you will pay any closing costs and other fees that are listed in the loan estimate.
What is a cash-out mortgage refinance?
One option that’s available for you when refinancing is a cash-out mortgage refinance. With this option, you’re able to “cash-out” some of the equity that you have built up in your home. Remember, your equity is the difference between the value of your home and what you still owe on your loan.
For example, if your house appraised at $400,000 and you still owe $300,000 on your existing mortgage — meaning you have $100,000 equity in your home.
Let’s say you need $20,000 for an expense and opt to do a cash-out refinance. Your new loan would be for the $300,000 that you still owe on your existing mortgage — plus the $20,000 you take out in cash. That means your new loan is for $320,000, and the excess $20,000 can be used to make a large purchase, pay for a financial emergency or consolidate debt.
The pros of this option are that you can get access to a large sum of cash quickly, and you can take out some of your equity without the need to sell your home. The cons of a cash-out refinance are that it increases your debt obligation, may breed bad spending habits and could reintroduce the need for private mortgage insurance (PMI), depending on how much you cash out.
You shouldn’t move forward with a cash-out refinance unless you have a good reason for needing the money and have discussed the pros and cons with a financial professional.
How to calculate your break-even point for closing
Because you still have to pay closing costs when you refinance your mortgage, it will take some time before you break even on your financial move. The point at which you’ll save enough on your monthly payments to make up for the closing cost expense is known as the break-even point.
If you’re planning on selling your home before the break-even point, you’ll end up losing money on your refi. Using a break-even calculator can help you determine when you’ll start to see savings from your refinance. It can also help you to decide if refinancing is the right option.
How long is the process of refinancing?
The exact time it takes for your refinance to close depends on the mortgage company you choose to work with. According to Rocket Mortgage, the average closing time on a refinance is around 30 to 45 days.
The exact time depends on a lot of factors that may be out of your control, like appraisals and inspections. There are a lot of other parties involved in the process, and you may find yourself at the mercy of other people during the mortgage process.
The speed of the process has slightly increased over the years thanks to the electronic submission of documents through mobile and web applications. However, many of the processes involved still take place offline.
Is now a good time to refinance your home?
With interest rates at historic lows, an opportunity may exist for you to benefit from a refi. Refinancing can help to lower your monthly payments, gain more favorable repayment terms and save on your overall interest costs.
Take note that even a small percentage change on your interest rate can mean massive savings over the life of your loan. If you keep your payments the same amount, you may be able to shorten how long it takes you to fully pay off your home.
COVID effect on mortgages
In response to the economic downturn, the Federal Reserve lowered interest rates to try and jumpstart the economy. The initial effect was a dramatic drop in mortgage rates. People flocked to banks and lenders to refinance and take advantage of the opportunity.
Because of the dramatic increase in demand, mortgage rates shot back up. Thankfully, this increase only held for a short while, and rates have since dropped back down toward the historic lows. The Fed currently projects no increases in prime rates (which drive changes in mortgage rates) through at least 2022, which means the opportunity to look into refinancing still exists.
Currently, the national average is 2.96% for a 30-year fixed-rate mortgage loan and 2.46% for a 15-year fixed-rate loan.