constantly low mortgage interest offer many homeowners the chance to lock in better rates and lower their monthly payments by refinancing. In other words, a mortgage review can be a great way to free up money for other important expenses or to grow your savings.
Homeowners who refinanced their 30-year fixed-rate mortgage in 2020 save an average of $2,800 per year, according to mortgage buyer Freddie Mac. With rates hovering around 3%, homeowners who refinance now can save a similar amount depending on their current rate, as well as the age and size of their mortgage.
However, refinancing a mortgage takes time. In April, it took an average of 53 days to close a refinancing loan ICE Mortgage Technologies. That’s one day longer than in March and 14 days longer than in April 2020. The sooner you get started, the sooner you can start saving on your monthly loan payments.
Follow these seven tips to help you start the refinancing process.
1. Set a refinancing target.
Most homeowners refinance to get a lower interest rate and, as a result, lower their monthly payments. However, that is not the only reason to refinance.
Different types of loans offer different benefits.
You may want to switch from a variable rate mortgage to a fixed rate mortgage to guarantee a lower interest rate permanently. You may want to switch from a 30-year loan to a 15-year loan to pay off your mortgage faster. If you have sufficient equity, you may also be able to save on mortgage insurance by switching from a FHA loan to a regular mortgage.
You may have recently been dealing with high medical bills, unexpected home repairs, or other expenses that weigh on you financially. If you have built up sufficient equity in your home, a payout refi will allow you to not only refinance your loan, but also withdraw additional money.
Knowing what you want to achieve with a refi will help you determine what type of mortgage product you need. Consider all the options to see which works best for you.
2. Check your equity.
You may be eligible for a conventional refi loan with just 5% equity in your home, according to Discover home loans. However, most lenders prefer that you have at least 20% equity.
If you have more equity, you may qualify for a lower interest rate and lower fees because lenders will view borrowers with higher equity as having less borrowing risk. More equity also means that you are less likely to owe more than the home is worth when home prices fall.
To get an estimate of your net worth, subtract your current mortgage loan from the current market value of your home. The result is your equity. Contact a knowledgeable local real estate agent to get an idea of your home’s value. Zillow’s home price estimate can also be a good rough starting point.
You must also prepare your home for an official appraisal, which is part of the refinancing application process. Have documentation on hand about any improvements you have made to the home. (For example, have you added a bathroom or replaced an old roof?) It can’t hurt to clean and organize your home to get it back to working order.
3. Check your credit score.
Before making any loan decisions, it is important to check your credit score and your credit report.
Your credit score will largely determine how favorably a lender will offer. The higher your score, the lower the rate you qualify for and the lower your monthly payments. If you have a low score, look for ways to improve your credit score well before you apply for a loan.
Your credit report shows the information on which your score is based. Here you can check for errors that could negatively affect your credit score. If you find errors in your report, you can contact the credit bureaus to have these items removed. Be prepared to provide documentation proving the error.
As part of the consumer protections instituted by the CARES Act, you can get a free weekly credit report from one of the major reporting agencies until April 2022. (You are normally entitled to one free report from each credit reporting company per year.)
You should also be aware of what factors can cause a temporary blow to your credit score. Applying for credit cards, personal or car loans just before, at the same time, or just after applying for a refi will lower your score, albeit temporarily.
4. Do the math to see if refinancing pays off.
Make sure you understand the cost of a new loan before applying for a refi. The closing costs for refinancing are usually between 2% and 5% of the total loan amount. For a refi to make sense, you need to be able to recoup these closing costs and save money in the long run.
To determine if it’s worth it, you need to calculate your breakeven point. This refers to how long it will take for the savings from the new loan to exceed the cost. You can calculate the break-even point by dividing the closing cost of the loan by the amount you save each month.
For example, if your closing costs are $5,000 and your monthly savings are $100, your breakeven point would be 50 months or about four years. Then refinancing probably makes sense if you plan to stay in your home for more than four years.
An easy way to find out if a refi is right for you is by mortgage refinance calculator.
5. Make sure your mortgage papers are in order.
Even with recent advancements in the online application process, you will still need a lot of documentation proving your financial willingness to refinance.
The documents you should have on hand include your last paychecks, the last two years of W-2s, information about your current home loan, as well as information about property taxes and home insurance.
If you’re self-employed or have a non-traditional job, have two years of bank statements ready. You may also need a profit and loss statement from your bank, the last two years of 1099 forms, and customer invoices as proof of income.
A lender may have additional documentation requirements depending on their initial assessment of your finances. Once you’ve chosen a lender, find out what other requirements are so you can arrange them in advance. This will make the application process a lot smoother.
6. Find a mortgage lender.
Don’t just take the first interest offered to you. You should compare rates and terms from at least three different lenders to see which one offers the best package for your needs.
You should also consider different types of lenders. Compare rates from major banks, online lenders and local credit unions. If you have a long-term relationship with a financial institution that also offers home refinancing, contact them as well. You may be able to negotiate a better rate if you already have other financial transactions with the lender, but not always. Don’t assume that the lender you know will give you the best deal.
7. Lock in your rate.
Once you’ve found a lender that offers the terms and rate that’s best for you, lock in your interest rate.
Although still very low, mortgage rates are on the rise since the beginning of the year. An interest rate lock ideally guarantees that your interest rate will not rise before it closes.
However, rate locks are usually created for periods of 15 to 60 days. Because lenders take a little longer to close these days, you may want to opt for a longer lock. While some lenders may not charge for a rate lock, others will. Rate lock fees can range from 0.25% to 0.50% of the total loan amount. If your loan does not expire on time, extending the blocking period may lead to additional costs.
The key with a rate lock is timing. Consult your lender to find out how long it typically takes to close, then lock in the rate for that time.
A note on mortgage interest deduction.
If you’re struggling to make your mortgage payments due to the COVID-19 pandemic, it may be a good first step to see if you’re eligible for a loan refinance.
Refinancing your loan can bring your mortgage payments within your budget. However, if refinancing isn’t an option because you don’t have enough income or your credit score has taken a hit, consider applying for a deferral of payment from your lender.
Extended as part of the CARES Act, forbearance allows homeowners to pause their mortgage payments for an initial six-month period. If conditions do not improve within that time, a maximum of two six-month extensions can be requested. The deadline for requesting an extension has been extended several times, with the last extension expiring on September 30.
The interrupted payments will not show up on your credit report as late payments, and patience will not negatively affect your credit score, but the fact that you have requested an interruption of your payments will show up on your credit report. Potential lenders can see this information and that can affect your desirability as a borrower.
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