You may have recently read in the news that mortgage rates have decreased significantly, dropping by two percent from the 8% rates we saw last year. This presents a great opportunity for recent homebuyers, potentially leading to substantial savings on your mortgage. If you’re a recent homebuyer, you may want to consider refinancing.
What is a refinance?
A refinance, or refi for short, is a flexible financial tool that allows you to revise and replace the terms of an existing mortgage. When you decide to refinance a mortgage, you’re taking control of your financial future, aiming to change your interest rate by paying off the first mortgage with a new one that offers better terms.
When should you refinance?
When refinancing to lower your mortgage rate, you want to make back the cost to refinance through your monthly savings within two to three years. This is known as the break-even point, when the amount you save exceeds the amount you spent to do the refi, including closing costs and upfront charges. The general rule of thumb is that refinancing makes sense if you can lower your interest rate by at least 1%. However, the impact of this 1% decrease can vary depending on your loan size. For example, if you owe $200,000, you’ll want to see a 1% drop. But if your loan balance is $400,000, a reduction of just 0.5% might be sufficient to make refinancing worthwhile. Click here to see when your break-even point is.
Other benefits of refinancing
Besides the lower interest rate benefit of refinancing, there are other benefits. If you had put down less than 20% when you got your first mortgage, requiring you to pay Private Mortgage Insurance (PMI), when you refinance, you may now have more than 20% equity, enabling you to remove the monthly PMI mortgage.
Another benefit is that besides paying off the first mortgage and financing the closing costs, Freddie Mac allows you to take out an additional 1% for you to take for yourself. If you want more than 1%, you may want to consider a Cashout Refinance.
Cashout Refinance
There is another refinance known as a cashout refinance, where a regular refinance to lower your interest rate is known as a rate and term; a cashout allows you to take out additional funds besides paying off your first mortgage. The benefits are having extra funds to consolidate debt or use for other necessities. The only drawback is the rate will be slightly higher than the rate and term. The LTV ratios are lower, 80% on a one-unit Primary home and 75% on a one-unit investment property, for a rate and term 97% and 80%.
Understanding Closing Costs
Hard Costs
These are the actual fees you pay to refinance, including bank fees, title fees, and appraisal costs. Typically, these should be under $4,000.
Soft Costs
Soft costs aren’t precisely closing costs, but they’re still an important factor. They include the funds needed to pre-fund your new escrow account. When you refinance, your new lender will require a new escrow account to cover property taxes and insurance. You’ll need to provide this upfront because your current lender’s escrow funds can’t be transferred to the new lender. What’s left in your escrow account from your first lender will be refunded to you within a few weeks after paying off the mortgage, so it’s better if you don’t roll in these fees and pay interest over 30 years.
Streamline
For borrowers who received an FHA loan, there are options to get a Streamline refinance; the benefits are that there is no appraisal, hard credit pull, or income review. If you have an FHA loan (or any other government-backed loan), you should strongly consider this option.
Conclusion
A borrower for whom I had closed an FHA mortgage a year ago; after I ran through his numbers, I could refinance him with a Streamline refinance, saving him close to $700 a month since his interest rate went from 7.1% to 5.275%.
Refinancing is a great idea to lower your mortgage payments, but as with everything mortgage-related, be sure to speak with a competent mortgage broker to review and be sure it’s a wise decision for you.
