If you’ve been weighing up whether or not to pay off your existing loan and replace it with another one, also known as refinancing your mortgage, then our handy guide is here to help. Sometimes refinancing sounds like a good idea on paper, but in reality it’s not always possible or practical. Lenders are tightening up their rules and regulations, making it more difficult to acquire a loan, so we’ve put together a complete guide to help you decide whether it’s the right time to refinance.
Statistics show that now is the best time to refinance your mortgage;American homeowners are losing out on a collective $13 billion a year by not refinancing. The combined promise of being able to pay off your mortgage quicker while also saving yourself money in the long-term draws many people to refinance, even though the monthly payments may be slightly higher than the amount they’re currently paying. When considering refinancing your mortgage, these are the top reasons to take out a new loan.
Most people refinance when the interest rate is significantly lower than the one they currently pay on their existing loan. In the past, it was common knowledge that the interest rate needed to have fallen by at least 2% for refinancing to be financially worthwhile. However, in 2017 many lenders are saying that savings of 1% are enough to make a difference to homeowners’ bank balances. There are a couple of benefits of a lower interest rate, firstly it saves homeowners money on their monthly repayments and makes it easier to build equity on your home. Over the past few years, interest rates in America have fallen fairly consistently from an average of 6.03% in 2008 to a record low of 3.35% in December 2012, they haven’t increased much since then.
As interest rates fall, homeowners are given the chance to refinance to another loan which is similar in monthly payment size, usually there is a slight increase, but has a shorter term. This means that you could be repaying your loan for much less time, without the need to pay much more, which is ideal for many people who are financially stable and considering their future. For example, for a 30- year fixed-rate mortgage on a $100,000 home, refinancing from 9% interest to 5.5% halves the term to 15 years and only increases the monthly repayment from $804.62 to $817.08!
Choosing between the two types of mortgage available is one of the most difficult decisions you’ll make. Do you opt for an adjustable-rate mortgage (ARM) which starts out with low rates but can increase significantly over time, making repayments huge, or do you go for the safe bet fixed-rate mortgage and then miss out if interest rates fall? If you feel that you made the wrong decision when you initially took out your mortgage, refinancing could be the solution for you.
If you’re currently paying high fees on your ARM due to interest rate rises, switching to a fixed-rate mortgage can help you to save money and removes the worry of spikes in the rate occurring in the future. On the flip side, switching from a fixed-rate mortgage to an ARM can be a great financial move in times when the interest rates are falling significantly year on year. It all depends on the current economic situation!
So, the economy is in your favour and interest rates are on the decline – you should definitely go ahead with that mortgage refinance, right? Not quite, you need to consider your personal circumstances before you make any financial decisions that are going to affect you at least for the next few years. Ask yourself the following questions to work out whether or not it really is the right time to refinance.
One of the major roadblocks which stop people from refinancing their mortgages is bad credit scores. If your credit habits or your income has deteriorated over time since you first took out your mortgage, perhaps you got a bit behind on credit card repayments or you regularly borrow more than you can afford, you might not qualify for the lower rates available today. In America, the average credit score in 2015 was recorded as 695 which is classed as ‘Average or Fair’. In general, mortgages work something like a sliding scale; the lowest rates go to those who have the highest credit score – usually 720 or above. If your score is below 620, you’re going to struggle to qualify for any mortgage and you might need to build up your credit score before you apply for refinancing.
Depending on where you are in your life, you’ll need to consider your overall financial plan. Instead of fixating on paying off your mortgage, you need to make decisions which consider the future of yourself and your family too. Will you still have enough disposable income to contribute to retirement savings or college funds for your children? Financial experts recommend saving for between six and twelve months before committing to a shorter and more expensive mortgage through refinancing. Generally, it’s a decision you can only make if you are financially stable and are receiving a wage that leaves you with plenty of disposable income.
If you’ve found your ‘forever home’ refinancing may well be worth your while, as you’ll be there long enough to reach the break-even point, where your savings outweigh the costs. However, if you’re planning to move to a larger property or are currently only in your first home, refinancing simply isn’t the best decision to make at this stage of your life. Plus, if you’re already close to paying off your mortgage, again refinancing probably isn’t worth it due to the additional upfront costs created. Remember, refinancing a mortgage is a time consuming and stressful process, and one that comes with closing costs and a mountain of paperwork. It’s estimated that a $200,000 refinance can cost up to $5,600 in closing costs, so if you don’t currently have this kind of money to play with then it’s not the right time to refinance.
Before committing to refinancing, you’ll need to make sure you understand exactly what you’re signing up for. Many American homeowners have loans which come with certain restrictions, which could mean that the actual financial benefits you receive from refinancing are fairly limited. Conduct thorough research when making this decision, otherwise you could end up out of pocket. Remember, you’ll be assessed by a lender in depth to decide whether or not you’ll qualify for a refinance. Your current income, any other loans you have outstanding, and the current value of your home will all be assessed.
Speaking of property value, another reason many people don’t end up refinancing their home is because they simply don’t have enough equity. Homeowners are required to have at least 20% equity before they can qualify for a new loan. If your home isn’t worth more than your current repayments, which is pretty common across America as the housing slump continues, you can still apply for a refinance but you’ll have to choose your lender carefully. Unfortunately, if you’ve ever taken out a second mortgage or used their equity you might not qualify either. If you’re considering refinancing purely to tap into your equity to pay for major expenses, such as renovation or repairs, this is not generally advised. It’s rarely worth your while to add more years onto your mortgage repayments, especially if you’re already in financial difficulty. Some experts consider this a slippery slope towards bankruptcy in the future. So, refinancing for equity purposes is a top reason not to remortgage your home!
Refinancing can be a great financial move if you have a steady income, a good credit score and the interest rates are low and appear to be staying low. Shortening the term on your mortgage can save you a considerable amount of money over the years but it’s important not to rush into any major financial decision. You need to make sure that you’ve considered all of your options and researched the terms of your current loan, otherwise you could end up paying high closing fees and putting yourself through a lot of hassle of no reason! Don’t be blinded by the promise of paying your mortgage earlier either, be sure to consider all of your future financial goals and make sure you can afford to put savings in place for the future.
If you’re a first time buyer and need more guidance on the mortgage process, why not check out our guide to purchasing property for the first time?
Finally, the last major choice that you need to make is whether you want a jumbo loan or conforming loan, which concerns the overall size of your loan. Therefore, this completely depends on the amount that you intend to borrow for a mortgage loan, which will then determine whether you qualify for a jumbo loan or a conforming loan. For a conforming loan, you must meet the requirements of Fannie Mae or Freddie Mac, which are two government-controlled corporations that purchase as well as sell mortgage-backed securities. For a better understanding of these two corporations, all you need to know is that they buy loans from lenders who supply them, and then sell to investors. When after a conforming loan, the amount you intend to borrow will have to fall within their maximum size limits, otherwise you’ll be restricted to the jumbo loan.
Therefore, as you should understand by now, you will be eligible for a jumbo loan if you exceed the limits that both Fannie Mae and Freddie Mac establish. Because of the mammoth size that a jumbo loan offers, it can often prove as a risk for borrowers, so there are specific requirements needed to finalise a deal with a jumbo loan. Firstly, it’s paramount that you have an excellent credit score and larger down payments compared to those of conforming loans. In addition, interest rates are often much higher with jumbo products, so you need to be able to afford all of these mortgage costs without putting yourself in serious financial risk.
Now that you’ve had a thorough rundown of what each loan offers borrowers, we hope that you are now able to make an informed decision about the loan that is best for you and your requirements. The research doesn’t have to end here though, as there are still many things that need to be considered before getting your mortgage loan, such as who are you going to use for your loan? Once you’ve thoroughly considered all of these, and got a couple other things in order, you should be ready – happy moving!