You may be considering refinancing your home mortgage. Here is what you need to know before you pursue the process. For many homeowners, now is a good time to refinance because they can lock in their interest rates before they go higher and lower their monthly payments.
How refinancing your home works
Refinancing a mortgage means that your current mortgage will be paid off. In return, the homeowner obtains another mortgage, usually with a lower interest rate that will simultaneously lower the monthly payments.
The two major reasons many homeowners will consider refinancing is to seek a lower interest rate or to obtain a fixed-rate mortgage because their current adjustable-rate (ARM) mortgage is set to end soon.
Mortgage rates are benchmarked to the 10-year Treasury note, which is a longer-term rate. One misconception that many people have is believing that mortgage rates are tied to the Fed funds rate, which is a short-term rate, said Tendayi Kapfidze, chief economist for LendingTree, which owns MagnifyMoney.
“Many people don’t take advantage of the opportunity to refinance,” Kapfidze said. “It’s always a good idea to really understand what your interest rate is and the terms of mortgage are so you can be aware of opportunities to refinance.”
As part of obtaining a new loan or mortgage in refinancing, you will restart the payment period all over again. For instance, if you are getting a 30-year fixed mortgage, the countdown to when your mortgage is paid off is reset to that point 30 years from closing on the refi.
Refinancing is very similar to the process that you undertook when you received a mortgage. It can take several weeks or longer to be approved because the lender will check your credit score and other financial information such as your income, even if the process is conducted online. Refinancing is not inexpensive and you will have to pay several fees that can add up to be several thousand dollars. Expect to pay 3% to 6% of your outstanding principal in refinancing fees, plus prepayment penalties.
What are the costs?
Because all lenders charge different rates for their refinancing fees, it is a good idea to shop around and find out which lenders offer discounts.
Homeowners should only seriously consider refinancing if they can lower their current mortgage rate by at least 50 basis points, or 0.50%, to compensate for some of the fees they will have to pay, Kapfidze said.
“People should definitely always keep in mind that there is an opportunity to improve your financial profile through refinancing,” he said. That can include setting up a lower payment amount or reducing your interest expenses.
The fees involved in refinancing include costs for origination, application, points, attorney/closing, appraisal, inspection, title search and title insurance.
The loan origination fee is the fee that the lender or broker charges to evaluate and prepare the mortgage loan. The cost is typically a maximum of 1.5% of the loan principal.
The application fee is not refundable, and usually ranges from $75 to $300. This includes the cost of checking your credit report and score and processing your loan. Even if you are not approved for a mortgage, you likely will have to pay this fee.
The points are fees paid to lower the interest rate of the mortgage. They are also known as a loan discount point. One point is equal to 1 percent of the amount of your mortgage.
An attorney fee is charged by the lender to pay for an attorney or title company to conduct your closing. This fee is typically $500 to $1,000.
When your current home is appraised as part of this process, the lenders will know its value is at least the same as the amount of the loan. This fee is sometimes part of the application fee, depending on the lender or broker you choose. If your home was appraised recently, the lender might consider waiving their requirement to undergo another appraisal. The cost usually is $300 to $700.
The inspection fee is the cost to check if a home has pests, such as termites, or other problems. This could include a more in-depth analysis of the structural condition of the home. In some states, the lender will also want to inspect and test the septic system and well and water system, if applicable. The inspection fee is $175 to $350.
The title search and title insurance fees cover the cost of researching the title on the home from property records. The lender wants to ensure that you are the owner of the home and to see if there are any liens against the property. The title insurance protects the lender in case any mistakes emerge when it is conducting a search for your title. The cost is typically $700 to $900.
While many lenders will offer “no-cost refinances,” it does not mean all your fees are waived. Instead, these lenders allow the upfront fees to be paid throughout the term of your loan, either by giving you a higher interest rate or increasing the amount of the loan.
The higher interest rate is paid throughout the entire term of the loan, often 15 or 30 years. This option usually means the homeowner spends more money in the long run because interest is being accumulated for the duration of the loan.
When the refinancing fees are included in your new mortgage, they are “rolled into” or “financed into” the principal amount. Even though you will not have to pay thousands of dollars of fees right now, you will be repaying the fees along with interest for the next 15 or 30 years.
What to consider before refinancing your home
Lower interest rates are not the only reason to refinance your mortgage. There may have been a change in your financial situation since obtaining the original loan that makes it a sensible move to take now, for example.
Before you decide to refinance your current mortgage, you should consider the impact of the following factors first.
- Lowering your interest rate
- Eligibility for refinancing
- Credit-score changes
- Decreasing length of loan
- Amount of equity in your home
- How long you plan on living there
- Lower interest rate for your ARM
Reasons you should refinance
Consider these possible advantages:
- Interest rates are lower today than when mortgage was obtained
- Your current monthly payments are too high
- Your ARM is ending
- You can obtain a lower interest rate, plus tap home equity with a cash-out refinance
- Your credit score has improved
- Your salary has increased
- Your property valuation has risen
Reasons not to refinance
These factors could make the decision less beneficial:
- You have had mortgage for many years
- You don’t plan on being in the home long-term
- Your credit score has declined
- You can’t afford the closing costs on a refinance
- Your debt has risen
- Negative amortization has occurred, which means you owe more on your mortgage than you originally borrowed
- Mortgage has a prepayment penalty
- Your salary has declined
- Your property valuation has declined
- You have an existing home equity line of credit (HELOC)
Refinancing can be a good option for homeowners who are seeking lower monthly payments and plan on living in their home for several years. Determine if the additional costs of refinancing are worth it for you. Shop around for the best mortgage rates and lowest fees. Use LendingTree’s refinancing calculator to see how much your lower monthly payments will be once the fees are calculated. Although many companies conduct all the paperwork electronically now, the process still can be lengthy.
“Now there are a lot of online lenders and refinancing can happen a lot more smoothly,” Kapfidze said. “It’s less of an onerous process than it used to be.”
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