You already have a mortgage, but you’re wondering whether you can qualify for a better deal. Good. Complacency isn’t a good strategy for saving money. Refinancing your home loan could be a smart move. Read on for a step-by-step guide of how to refinance your mortgage.
Figure out why you want to refinance
Your first step should be to determine why you want to refinance your mortgage. Although most people refinance because they want smaller monthly payments, the best reason is to save on interest. A rate reduction of just 0.5 percent can save you more than $20,000 on a 30-year mortgage of $200,000.
Add a term reduction to the same $200,000 mortgage and the savings could be huge. For example, shortening it from a 30-year to a 15-year mortgage could save you more than $137,500 in total interest. (Source)
Check your credit score
Homeowners with higher credit scores qualify for better, lower interest rates. According to FICO, the company that generates the most widely used credit scores among lenders, someone with subprime credit (620 to 640) can expect to receive a mortgage interest rate 1.6 points higher than a person with excellent credit (760 to 850). (Source) That’s huge. It equates to a $200 hike in your monthly payments, on a $216,000 30-year mortgage.
If your credit has improved since you first got your mortgage, you may qualify for a better rate.
Find out what your property is worth
Use free online services, such as Zillow and Trulia, to get an estimate. The current value of your home will determine whether refinancing is even an option. Lenders prefer to refinance mortgages on homes with a large equity. Equity is the difference between the value of your home and the balance on your mortgage.
If your home is not worth as much as your mortgage balance, you will struggle to find a lender. The same issue applies to mortgage loans that have a negative amortization – meaning your monthly payment is less than the interest you owe – because unpaid interest is added to the mortgage balance.
Don’t settle for the first offer (or denial) you receive. Refinance rates and costs vary widely from one lender to another depending on several factors, such as their risk assessment model and how hungry they are for new business. Reach out to at least three lenders. More is better in this case. Here are some options you may consider:
- Quicken Loans is one of the largest mortgage lenders in the United States with a streamlined application process. If you apply now, you could get a reply in less than 10 minutes.
- USAA is another excellent source of refinance loans. However, it is only available to members of the armed forces and their relatives.
- Blackhawk is an option if you don’t qualify for traditional bank refinance loans. Blackhawk is a peer-to-peer lending platform that connects investors directly with borrowers, which allows for borrowers to fund projects traditional lenders won’t consider.
Make sure you apply to all lenders within a two-week window. Every time you apply for a loan, a lender will make an inquiry on your credit score, which will ding your credit score. However, credit score algorithms consider multiple inquiries within a short period as a single inquiry, which won’t have much of an impact on your credit scores (Source).
Include all costs when comparing refinance loans
The APR on your loan does not include all the costs triggered by a refinance loan. You may have to pay for application fees, appraisals, credit report charge, title research, tax transfer fees and recording costs, to mention a few.
Ensure you’re not comparing apples and oranges. Ask for an estimate of all application and closing costs. Note that lenders are required to provide you with a Good Faith Estimate (GFE) within three days of receiving your loan refinance application (Source). The only fee lenders can charge before sending your GFE is a credit report fee.
Once you have GFE from all the lenders you plan to use, compare the overall cost of each offer.
No-cost refinance loans
There is no such thing as no-cost refinance loan. It’s a marketing trick. Instead of charging you up front, they include the costs into the loan. If you’re short on cash, they may be your only option. Just make sure you calculate their real cost when comparing them to other offers.
Lenders who offer no-cost refinances cover the closing fees by either charging a higher interest rate or adding the costs to the balance of the loan. Either way, you will be paying for the fees with interest for the life of the mortgage. Ask the lender to provide a comparison of the refinance loan costs, principal, and monthly payments using the regular and the no-cost options (Source).
Calculate your break-even point
Once you determine which is your best offer, it’s time to decide whether refinancing makes sense in your case. One way is to calculate how long it will take for the monthly savings of the new refinance loan to pay for the closing costs, also known as the break-even point.
For example, let’s say you have a $200,000 refinance mortgage that costs $2,128 in closing fees and reduces your interest rate by 0.5 percent. Incidentally, $2,128 was the average closing cost in the United States for a $200,000 mortgage, as of June 2016. (Source)
First, add up all the refinance loan closing costs. In our example, $2,128.
Deduct your current monthly payment from the monthly payment of the new loan. $57 (rounding up).
Divide the total closing costs by the monthly savings you will enjoy with the refinance loan. $2,128 / $57 = 37.33 months.
In this example, it would take roughly 37 months for the refinance loan to pay for itself. If you were planning to sell your home in less than 3 years, refinancing is probably not a good idea. On the other hand, if you’re planning to stay for 5 years or more, refinancing seems like a no-brainer.
This method only works with refinance loans where the new loan has lower monthly payments. If you are refinancing for a loan with a shorter term, you will usually save a lot of money in interest over the life of the loan, but your monthly payments will go up. In that case, calculate your overall interest savings and divide by the number of months in the new term to get the monthly savings. Then use the same method above.
Organize your documents
Save yourself time and stress by preparing a file with all the documents lenders will request. Once you do that, you just make copies for every lender you apply with. The specific documents you’ll require vary depending on the lender and your source of income. However, you typically need:
- Pay stubs or some other proof of income
- Tax returns, W2s and 1099’s (if you’re self-employed).
- Credit report
- A detailed statement of all your outstanding debts. Some lenders also require alimony and child support payments.
- A detailed statement (and proof) of all your assets, such as savings accounts, stocks, retirement accounts, and other real estate properties.
The bottom line
Just because you can refinance your mortgage, doesn’t mean you should. Unless you can’t afford your current mortgage payments, resist the temptation of refinancing a loan just for a lower monthly payment.
Remember that shopping, comparing, and negotiating the terms and rates of your refinance could save you thousands of dollars over the life of the loan.
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