Back in the day, you may vaguely remember your parents throwing a mortgage-burning party to celebrate finally owning their home free and clear. Now you’re a homeowner, but you’re a long way from burning your mortgage. You’re considering refinancing your mortgage, but you’re wondering if this is the right time to do so.
The goal of refinancing is to reduce the amount that you pay to own your home outright. Several factors come into play in determining whether and when refinancing your home moves you toward that goal. Some factors, such as plunging interest rates, are obvious reasons to refinance. Other good reasons to refinance relates to your personal circumstances, such as getting a new job. Other factors, such as the length of your mortgage or eliminating private mortgage insurance, have more potential impact on how much you ultimately pay for your mortgage than you might initially realize.
Lower Interest Rates
If you obtained your mortgage when interest rates were high, refinancing could save you a significant amount of money once interest rates fall. Getting a $200,000 mortgage with an interest rate reduction of 1.5 percent translates to a savings of $3,000 over a single year. You can get a mortgage with one percent lower interest rate. You may also save money by refinancing from an adjustable-rate mortgage to a fixed-rate mortgage during sustained periods of low-interest rates. But watch out for points and lender fees, which can take big chunks out of any savings you might otherwise gain.
Reduced Mortgage Length
All other factors being equal, you will save significantly if you can manage a mortgage with a shorter mortgage term, even if your monthly payments are higher. The differences lie in interest savings. Mortgage rates for 15-year fixed-rate mortgages average about 1 percentage point lower than 30-year fixed-rate mortgages, according to Interst.com For a $200,000 fixed-rate mortgage at 4.5 percent interest; you’ll pay about $165,000 in interest. With a 15-year fixed-rate $200,000 mortgage at 3.5 percent interest, you’ll pay only $57,000 in interest – a savings of 65 percent.
Improved Credit Profile
Have you just received a promotion or a big raise? While income does not directly determine your credit score, your asset to debt ratio plays a significant factor in how lenders view your creditworthiness. If you finally paid off your student loans or that monster credit card bill, your asset to debt ratio may qualify you for refinancing at a significantly lower interest rate. Cleaning up late payments or other credit blemishes may also improve your financial profile. If your credit report and FICO score have improved recently, refinancing your mortgage is worth consideration.
Increased Equity and Value of Your Home
If you bought your home during the depths of the Great Recession, you might have paid a rock bottom price. Depending on where you live, the value of your home may have increased significantly, making it more likely that you could be approved for refinancing. Likewise, if you’ve built significant equity in your home through years of payments, the lender may be more likely to approve an application to refinance your mortgage.
Dumping Private Mortgage Insurance
You may have purchased your home with less than a 20 percent down payment. Unless you were able to qualify VA financing, you were probably stuck with buying PMI. But if you have accumulated at least 20 percent equity in your home, either through several years’ worth of monthly payments or an increase in your home’s value, consider refinancing to obtain a mortgage without PMI. Especially if your current lender refuses to cancel PMI, refinancing your mortgage can be a good idea. Getting rid of PMI means that more of your monthly payment goes directly toward reducing your principal, allowing you to pay off your home faster – definitely a smart move.
Available FHA and VA Financing
If you qualify for an FHA-guaranteed mortgage, you can refinance your home with as little as 2.25 percent accumulated equity. If you or a member of your family is eligible for a Veterans Administration loan, you are not required to have accumulated any equity in your home. Especially if your present mortgage interest rate is high or if you have an adjustable-rate mortgage, an FHA or VA loan can make sense. If your mortgage is 78 percent or less than your home’s present value, you should not have to pay mortgage interest on an FHA loan. VA loans do not require mortgage interest even if you have no equity in your home. You may qualify for an FHA or VA loan with a lower FICO score than would be required for a conventional loan.
Getting Out from Underwater
Maybe you would like to refinance your home, but you’re presently underwater on your mortgage. You may still qualify for refinancing under the Home Affordable Refinance Program (HARP). If Fannie Mae or Freddie Mac purchased your mortgage before June 2009 and your loan to value ratio is greater than 80 percent, a HARP loan may allow you to ease the burden of your mortgage at least somewhat. If you’re presently current on your mortgage payments and have maintained a good payment history for at least the previous 12 months, you have a good shot at being approved. Best of all, if you don’t have PMI for your present mortgage, you won’t be required to purchase PMI to qualify for a HARP loan, either.
Shop Around for the Best Deals
If you’ve determined that this is an excellent time to refinance your home, make preparations to get the best possible deal on your new mortgage. Hold off on making other big purchases and maintain current status on your credit cards, car note and other financial obligations, especially your mortgage. Credit reporting agencies consider several inquiries of a single type made within a brief window – generally about two weeks – to count as a single inquiry, which has a minimal detrimental impact on your credit score. So go ahead and shop around to get the best deal, but don’t drag out the process too long to prevent your credit score from taking a big hit.
Audrey Henderson is a Chicagoland-based writer and researcher. She holds advanced degrees in sociology and law from Northwestern University. Her writing specialties are sustainable development in the built environment, policy related to arts and popular culture, socially and ecologically responsible travel, civic tech and personal finance.