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If you haven’t kept up with mortgage interest rates lately, we can’t blame you.
But if there’s one thing you should know, it’s that newly low rates present homeowners with an opportunity to lower their monthly mortgage payments and save thousands of dollars over the term of their loan. Due to the COVID-19 pandemic and the economic damage that’s come with it, the government has lowered both short- and long-term interest rates to encourage people and institutions to invest and keep the market stable.
Refinancing, as a result, has become an increasingly enticing opportunity, and experts say it could be a crucial lifeline for many people. Ironically, the economic downturn has created a positive climate for a “refi,” as the move is known. “The economy is not in great shape right now,” says Greg McBride, CFA, chief financial analyst at Bankrate.com. “The economic lockdown is impacting everyone. But interest rates are at record lows, and that means it’s not a bad idea to consider refinancing.”
But it’s not right for everyone. Refinancing “can really be onerous, and it may not save you that much money in the end,” says Jill Schlesinger, CBS news analyst and author of “The Dumb Things Smart People Do With Their Money.”
So what happens during a refinance — and is it right for you? Here’s what you should know:
What Is a Mortgage Refinance?
A mortgage refinance is when you take out a home loan to replace your existing mortgage. The new mortgage can be taken out with your current lender or a different lender. Homeowners usually refinance to take advantage of better interest rates or more favorable terms.
When to Refinance Your Mortgage
There are a number of reasons why you would want to refinance your mortgage, but they all boil down to one thing–are you improving your current situation?
Common motivations to refinance are to lower your mortgage interest rate or reduce your monthly mortgage payment with a longer-term mortgage. Refinancing is also an option for switching from an adjustable-rate mortgage to a fixed-rate loan. For certain government-backed mortgages, like Federal Housing Administration loan (FHA), refinancing to a conventional mortgage may be the only way to get rid of the private mortgage insurance requirement.
If you have enough equity built up in your home, you may be able to do what is known as a cash-out refinance. A cash-out refinance works just like a normal mortgage refinance except you take out a loan for more than what you owe on your existing mortgage. Then you can use the extra money for things like home improvements or paying off other high-interest debt.
How to Refinance Your Mortgage
Refinancing is fairly simple, in theory. It means taking out a new loan to pay off your current mortgage, either with your current loan holder or a new one. Typically this is done to take advantage of low mortgage rates or for other reasons. Freddie Mac (the Federal Home Loan Mortgage Corporation) has posted 30-year rates of 3.23% and 15-year rates at an unusually low 2.77%. Of course, nothing is static in finance, but the experts we talked to believe these rates should be around for a while as the economy recovers.
McBride and our experts outlined the following procedures you should follow for a successful refi.
1. Set a financial goal
First, take a look at your finances. Do you have a month-to-month budget? If not, now would be a good time to create it. Consider what you’re hoping to do with your mortgage refinance. Rick Robertson, a certified mortgage planning specialist with Axia Home Loans in Bellevue, Washington, says there are four main reasons people refinance:
- To lower the interest rate on their mortgage, increasing monthly cash flow. “This can be very helpful and redirect a monthly cash flow into other areas that are more pressing at the current time,” says Robertson.
- To shorten the loan term, for example, from 30 to 20 years, which can save interest over the long term.
- To take cash out of the refinance and use the equity you have in your house to consolidate debt, pay for education, or make home improvements; this is called a cash-out refinance.
- To get a low, fixed-rate mortgage instead of a variable rate mortgage.
Think about what you’re hoping to gain from your refi, and share that when you talk with bankers or mortgage brokers, so they can better understand what type of refinance might make the most sense for you.
2. Gather necessary documentation
We asked McBride what his best advice was for people wanting to refinance. His answer was simple: Come prepared. Collect your financial documents and have them available for lenders. It’s best to have these ready when it’s needed to make the process proceed more smoothly. Documentation you will likely need to refinance:
- Pay stubs
- Tax documents, such as W-2s, tax returns, and 1099s
- Proof of homeowners insurance coverage
- Statement of debts, such as car loans, student loans, mortgage(s), any line of credit
- Documentation of assets (savings, stocks, bonds, 401(k), CDs, etc.)
- Copy of title insurance
3. Shop and compare rates
Even if you’re quarantined at home, you can still shop and compare rates without stepping foot into a bank. Whether you use a new lender or a mortgage broker you’ve worked with before, choose one you trust. Shop around and compare rate offers from multiple lenders to ensure you’re getting the best deal.
McBride advises it’s worth it to do the research, but beware of low advertised rates. Depending on your credit history you may not qualify for what you see. In addition, sometimes advertised rates may have hidden terms attached.
That’s why some consumers prefer a broker. A mortgage broker acts as a middle man between lenders and clients. Brokers come with a fee, but they understand your credit situation and will be able to shop lenders and rates on your behalf.
If you decide to do the legwork yourself, to help you decipher each offer the Federal Reserve Board provides this handy mortgage refinance shopping checklist with 13 questions to ask each lender.
4. Apply with at least three lenders
According to the experts, you don’t need to limit yourself to one potential mortgage broker or lender when you’re submitting your applications. Consider talking with several lenders and brokers. McBride says three is a good number of lenders to speak with and get loan estimates from.
This advice is especially important if your credit rating is not quite as good as it could be. Each bank has its own criteria for determining who to lend to. If one bank turns you down, another may not. You may also find the rates at one to be preferential, but the only way to know which bank is the best fit for your loan is by applying to more than one.
Aim to evaluate different lenders within a short period of time. Once you initiate a credit inquiry for a mortgage refinance, you then have 14 to 45 days (depending on the scoring model that’s used) to have additional credit pulls from competitors without negatively impacting your score. Multiple mortgage loan credit checks will be counted as one check if performed in that window.
Never settle on your first offer. Shop around for the best rate, broker, and lender.
You’ll probably find anyone who is considering your mortgage application will want an appraisal of your home by a professional. That’s not something to panic about, and you may find your house is worth more than you realized. But on the other hand, you might also find your house is worth less than you expected. As long as the appraisal doesn’t find your house is worth less than the new mortgage is for, it won’t impact your refinancing.
The standards for appraisal have changed since the pandemic; most homeowners are hesitant to allow people into their homes. According to McBride, you may see more “external appraisals, drive-by appraisals, or an automated valuation model called desktop appraisals in lieu of physically inspecting both inside and out.” If these alternatives are not an option, the Federal Reserve is allowing you to postpone your appraisal up to 120 days after closing on certain types of loans.
6. Choose a lender and lock in your rate
Once you’ve received replies on your loan applications, you’ll be able to make your choice. Your decision will largely depend on who offers the lowest rate, but there may be other elements to take into consideration. Do you want a lower rate or shorter term? Is good customer service a factor for you? Do you want to go with a local banker to support local business in the community? Do you like the financial security of a large, corporate bank? Think about what’s important to you, then lock in your rate with your chosen lender.
7. The closing
In the final step of the mortgage refinance process, a closing involves signing what may seem like endless documents, including the final closing disclosure, which details the closing costs. By this time, there will have been an assessment of your home, and any necessary details — such as repairs contingent on the deal — will have been taken care of. The actual closing will include you, a bank or broker representative, and probably a lawyer. If you’re paying closing costs up front, you’ll need to bring a check with you. If you’re doing a cash-out refinance, you will have to wait three days for your money due to the right of rescission, which gives you three days to change your mind.
The Bottom Line
The refi process is not easy, says Schlesinger. All the more reason, she says, to do your homework: research your options, create a realistic budget, and be honest with what you’re trying to achieve through a refinance. How do you know when the best time is to look at mortgage refinance rates? We’ll look at this next.