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Should I Refinance My Mortgage?



Can you refinance your home if you’re waiting on storm repairs? I live in Louisiana and am still waiting for my house to get repaired after some damage in last year’s hurricanes. But I want to refinance now to get a lower rate before they rise too much. I’m afraid if I have to wait, I’ll lose my chance to refinance.

John in Louisiana

Ben Mizes, Clever Real Estate CEO answers…

Refinancing your home makes a lot of sense — if you can lower your interest rate, shorten the term of your mortgage, or just get yourself some needed financial relief.

Deciding when to refinance can be intimidating. Calculating the savings on reducing your interest rate by half a point, while also paying additional closing costs, is a lot more complicated than calculating typical home-buying fees.

Homeowners actually refinance fairly often. The median amount of time a borrower keeps a mortgage before refinancing is only 3.6 years, according to data from Freddie Mac. Knowing when to pull the trigger depends on a lot of factors, including interest rate trends and what concrete benefits a refinance will give you.

Let’s touch on how refinancing works, factors to consider before you refinance, today’s interest rates, and how repairs could affect your refinance.

How does a mortgage refinance work?

Refinancing your mortgage is pretty simple: You replace your existing mortgage with a new mortgage. If interest rates declined since you obtained your initial mortgage, you can lock in that new, lower rate, which will lower your monthly payments, and save you a lot of money over the course of your loan.

Keep in mind that you’ll pay closing costs when you refinance, just like when you bought your home since you’re getting an all-new mortgage. Closing costs average 2% to 6% of the mortgage amount, so be sure to take that into account when deciding if refinancing is worth it. Minimizing the closing costs on a refinance is harder than on a home sale, which offers many ways to save.

TIP: Experts recommend calculating a break-even point for your closing costs. You do this by figuring out how long it’ll be before your monthly refinance savings offset the money you spent on closing costs.

Divide your closing costs by your monthly savings: That number is how many months it’ll take to break even. Experts suggest aiming for a break-even point of 24 months or less, so if it’s going to take several years, refinancing might not make sense. In five or seven years, you’re more likely to be moving into a new home than staying put long enough to fully offset your refinancing costs.

What other factors should you consider for a refinance?

A lower interest rate

If you can lower your interest rate, refinancing is often a no-brainer. Even a quarter-point reduction adds up to big savings over the life of your loan.

Right now, interest rates are trending up in the U.S., as the Federal Reserve moves to combat inflation. But you could still be eligible to reduce your interest rate, depending on your circumstances.

Has your credit score improved since you got your initial mortgage? That could also be a great reason to refinance, as a better credit score could unlock better rates. Aim for a FICO score around 760 or higher, which is the level that gives you the best rates. Having a better credit score unlocks other perks too, like more flexibility to afford renovations.

You might also qualify for a lower interest rate if you put down cash for your closing costs. Always talk to your lender about how to optimize your interest rate!

A different term

The most common type of refinancing is called a “rate and term refinance,” which is when you simply change the rate or term of your mortgage to numbers that are more favorable to you.

That could mean a lower interest rate or a different term for your loan. A shorter term can save you a lot of money on interest payments since you’re paying off the principal over less time. (Going with a 15-year term instead of a 30-year term gets you a lower interest rate, too.) On the other hand, a longer term will lower your monthly payments, since you’re spreading the principal out over time.

Accessing your home’s equity

A cash-out refinance is when you refinance and convert some of your home’s equity into cash, essentially turning your house into an ATM. Though rates for cash-out refinances can be slightly higher than rate and term refinances, it’s still a cheap way to borrow cash when compared to alternatives like personal loans.

To qualify for a cash-out refinance, you must have 20% of equity or more after the transaction is finished.

If you’re looking at a refinance just for the cash, you may also want to consider a home equity line of credit or a home equity loan, which doesn’t come with cash-out refinancing closing costs. There are closing costs with both, but they tend to be much lower.

Getting rid of private mortgage insurance premiums

If you have a conventional loan, you can simply cancel your private mortgage insurance once you accrue 20% equity.

But if you have a loan through the Federal Housing Administration or the U.S. Department of Agriculture, it’s a little more complicated than that. FHA and USDA loans require you to pay mortgage insurance premiums for the life of the loan if you initially put down less than 10% — even after you accrue 20% equity. So, the only way to get rid of the mortgage insurance obligation is to refinance into a conventional loan once you reach that 20% equity threshold.

Most holders of FHA mortgages will be eager to do this at the earliest opportunity since mortgage insurance premiums are thousands of dollars a year.

Should you refinance before rates go higher?

Unless you have a good, pressing reason to refinance — for example, getting rid of mortgage insurance, locking in a much better rate than the one you have now, or pulling some cash out of your home — it probably doesn’t make sense to refinance just because rates are heading up. The one clear exception is if you have an adjustable-rate mortgage (ARM).

This type of mortgage offers a low initial fixed rate (and low payments) through an introductory period, but when that period ends, the rate goes up if current interest rates start to increase. That means that holders of ARMs can pretty safely assume their rates are going to rise in the future, so refinancing into a conventional fixed-rate mortgage now, before more rate increases hit, can be a smart move.

Should you perform or finish repairs on your home before you refinance?

Since you’re originating a whole new mortgage, you’ll likely need a home appraisal to assess your property’s worth. The new mortgage must be large enough to cover the balance of the old one. So, unless your home’s value has skyrocketed in a very short time, you want to get it in the best shape possible before the appraisal.

The appraiser will peg your home’s value by comparing it to similar homes in the area. If your home is in substandard condition or lacks amenities that are common in your market, your appraisal may suffer.

Experts recommend approaching the pre-refinancing period as if you’re trying to sell your house as soon as possible. If there are easy, obvious fixes or improvements you could make to your house, make them — and finish them — if at all possible, before you start the refinancing process. Make sure your home is being presented in the best light possible because the higher the home appraisal, the easier the refinancing — and the more equity for you. And when you eventually sell your house, you’ll be glad you put in the work.

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