Mortgage Refinancing Guide
When home prices fall and mortgage rates plunge, consumers start eyeing the refinancing market, many for the first time. It may be a great time to think about refinancing your mortgage, but it’s worth a bit of thought before taking the plunge, and as always, it pays to shop carefully. For starters, there are a whole host of questions to ask yourself, including:
- What is my current interest rate? If you financed in the past few years, chances are the interest rate drop won’t be great enough to compensate for all the new fees you’ll be paying on a refinance.
- How long do I have left on my loan? If you’re in the last 10 years of a 30-year note, for example, you’re likely past the bulk of your interest payments and are paying largely principal, so it might not make sense to turn back now. If your loan balance is well under the $100,000 mark, it may make no sense to refinance, given the new fees you’ll be rolling in to the new mortgage.
- What is the current value of my home? Ask a real estate agent for a list of nearby comparable values. Make sure you’re not underwater, meaning that the current market value of your home is less than the value of your current loan.
- What do I want to refinance for – to save money, to tap into my home’s equity, or to pay off my mortgage faster? This is hugely important. Think about why you are interested in refinancing, and whether you’d be better off moving from a 30-year loan to a 15-year mortgage, as the rates have never been lower. That would mean a higher monthly payment, though. If it’s strictly monthly savings you’re after, trading in your old 30-year mortgage for a more attractive rate may be the way to go.
- What shape is my credit in? More about this below, but you’ll need at least a 720 credit score to compete for the best deals.
- Is there any chance you’ll be selling soon? If there is any chance you’ll be looking to sell in the next couple of years, forget it: The fees you’ll pay on a refinancing mean you have to stay put to see the savings materialize.
- Remember that mortgage interest deduction? It’s going to drop if you refinance, so make sure you’ve worked out the difference in your taxes before you commit.
- Is there a prepayment penalty? If so, make sure you know the amount and have factored that into your decision process.
Each of these variables plays a major role in the decision to refinance. Experts cite the “2 percent” rule of thumb, meaning that if you have more than $100,000 left on your loans, and you can drop 2 percentage points or more in interest rates, refinancing makes a lot of sense.
For others, it’s the switch from a 30-year mortgage to a 15-year term that drives the bargain, albeit in the opposite direction: you’ll pay more monthly, but you’ll pay off your loan twice as quickly and save a ton in interest in the meantime. The rates on 15-year mortgages are below 3% these days, after all.
So, if you’re ready to get started on refinancing, let’s take it step by step.
First Step: Get that Credit Score in Shape
Credit is still incredibly tight, and the well-documented subprime mortgage debacle continues to make bankers more gun-shy than ever about taking even the slightest risk on a loan. That means your credit score needs to be as squeaky clean as possible.
A credit health check begins at annualcreditreport.com, where you can request your latest report. You can obtain a copy of each of your major credit reports (Experian, Equifax, TransUnion) annually, for free.
As you work through your credit report, keep a close eye out for errors. They can be corrected through corresponding with the reporting agency, and while it’s time-consuming work, you’ll be amazed how much the removal of a couple of incorrect items can do for your score.
Think about your credit score as the total of several variables the credit agencies keep track of and keep each in mind as you work to maximize your score. Pay particular attention to your payment history, the amount you owe on outstanding credit accounts and the types of credit you’ve used or applied for lately.
If you’re a bit lower in some areas than others, focus first on those. Many applicants suffer the most in terms of their credit history, and while there’s little you can do to erase past missed bills, you can start improving today by setting up all of your bills as recurring online payments, so you’re never late with another payment. The goal here is to maximize the positive information in your file, particularly on-time payments. Credit cards are a key to building your payment history, as they report payment information monthly to the credit bureaus.
Also be sure to take a look at the amount you owe on open credit lines, and think about consolidating debt onto a single line of credit. Leave those lines of credit open, though, as doing so will keep your credit utilization ratio from rising. Then chip away at any outstanding debt you have, credit cards first – that’s the most important thing to improve that score.
Once you’ve cleaned up any inaccuracies in your credit reports and have taken steps to shore up your finances, request your credit score. It’s a $14.95 investment, but you’re flying blind without it. A score over 720 qualifies you for the lowest rates and fees.
Next Step: Shop, Shop, Shop! And Negotiate…
The best strategy is to comparison shop by getting quotes from a range of lenders, but do so with a deadline in mind, or you’ll be starting over. Go with a mix of lenders, including a national lender, a local credit union, an online lender and a mortgage broker recommended by your realtor. Wallet Hub is an excellent way to comparison shop, as the site offers mortgage lenders from all over the country in one convenient location.
Make sure you ask each lender for a complete fees worksheet, detailing all of the associated costs, rather than simply the interest rate. And make sure you know the annual percentage rate, or APR, for each quote. The APR is the key comparative number here, because it takes all the associated expenses into account, including any points you’ll be paying, the closing costs and other miscellaneous fees. So one lender might come in with a lower interest rate but a higher APR – and it’s the APR, at the end of the day, that you want as low as you can get. Even when you have a handle on the APR, you’ll want to ask the lender about the specifics of closing costs, as some lenders can still introduce other fees at closing.
Also keep a close eye on “third-party charges” – these are closing costs paid to anyone besides the mortgage lender. Third-party fees typically include an appraisal fee, title settlement charges and state and local taxes, and generally stay constant from lender to lender, but again, it’s worth keeping a close eye for any deviation from the norm.
And remember to take into account both escrow costs and interest that accrues on the mortgage from the closing date to the beginning of the period covered by the first monthly payment, also known as per diem interest. Escrow reserves are funds held in an account by the lender to assure future payment for ongoing costs such as real estate taxes and hazard insurance. Your lender should present you with the formula for calculating per diem interest and escrow.
If you qualify with a healthy credit score, everything, and I mean everything, may be negotiable. Don’t hesitate to negotiate fees, points and closing costs. Take your quotes and shop them around.
Listen carefully to the competing lenders, and make sure you’re doing everything you can to lower closing costs. Points -- fees based on one percent of the total amount of the loan -- are perhaps the most negotiable item, so make sure you haggle. One way to lower your closing costs is to ask about what’s called a “yield spread premium,” in which you agree to a slightly higher interest rate in exchange for paying your points.
In fact, don’t be shy about asking for a zero-closing cost rate, either – you might find that the numbers work in your favor even if you take the slightly higher rate in a zero-closing cost scenario.
In a low interest rate environment, you might want to ignore the siren’s call of adjustable rate mortgages. Sure, ARMs will look even lower, but remember that they will adjust according to prevailing rates. If rates are as low as they have ever been, which way do you think they’ll be headed soon?
Once you think you’ve found your lender, go back to each of the competitors and make sure you have their final offer. That way you know you have done all you can to secure the best possible deal.
The bottom line is that time is of the essence should you decide that refinancing is the right option for you, so use this guide to get started.
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