Other than possible lender-imposed waiting periods after a mortgage loan closes, you can refi as many times as your heart desires. But you’ll want to crunch numbers and think about more than interest rates.
Homeowners choose to refinance for a number of reasons: to lower monthly payments, take advantage of lower interest rates, get better terms, pay the loan off more quickly, or eliminate private mortgage insurance.
Refinancing involves paying off the current mortgage with a second loan that has (hopefully) better terms. Borrowers don’t have to stay with the same lender—it’s possible to shop around for the best deals, and lenders will compete for that business.
Mortgage rates seem to be constantly in flux, moving mostly in parallel with the federal interest rate. Both were on a downward trend throughout 2020, and mortgage rates rang in the new year at 2.67% for a 30-year fixed loan and 2.17% for a 15-year fixed loan.
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Rates that low could mean the chance for homeowners to save significant money. But should a killer interest rate automatically trigger a refinance? Here are some things to consider before taking the plunge.
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The Basics of Mortgage Refinancing
Because a homeowner who refinances is essentially taking out a new loan, the cost of acquiring the new loan must be compared with potential savings. It could take years to recoup the cost of refinancing.
As with the initial mortgage loan, a refinance requires a number of steps, including credit checks, underwriting, and possibly an appraisal.
Typically, however, many homeowners start with an online search for the rates they qualify for. (A low average mortgage rate doesn’t necessarily translate to an individual offer—creditworthiness, debt-to-income ratio, income, and other factors similar to what’s required for an initial mortgage will matter.)
The secret sauce that makes up a mortgage refinance rate might seem like a mystery right up there with how car sellers price their inventory, but there are some common factors that can affect your offer:
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1. Credit score
As a general rule, higher credit scores translate to lower interest rates. A number of financial institutions will give account holders access to their credit scores for free, and a number of independent sites offer a free peek, too.
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2. Loan term/type
Is the loan a 30-year fixed? A 15-year? Variable rate? The selected loan repayment terms are likely to affect the interest rate.
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3. Down payment
A refinance doesn’t typically require cash upfront, as a first-time mortgage usually does, but any cash that can be put toward the value of a loan can help reduce payments.
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4. Home value vs. loan amount
If a home loan is extra large (or extra small), interest rates could be higher. But generally speaking, the less the mortgage amount is compared with the value of the home, the lower the interest rates may be.
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Some refinance offers come with the option to take “points” in exchange for a lower interest rate. In simplest terms, points are discounts in the form of a fee that’s paid upfront in exchange for a lower interest rate.
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6. Location, location, location
Where the property is physically located matters not only in its value but in the interest rate you might receive.
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What Types of Refinance Loans Are Out There?
As with first-time home loans, consumers have a number of refinance mortgage options available to them. The two most common types involve either changing the terms of the original loan or taking out cash based on the home’s equity.
A rate-and-term refinance changes the interest rate, repayment term, or sometimes both at once. Homeowners might seek out this type of refinance loan when there’s a drop in interest rates, and it could save them money for both the short term and the life of the loan.
A cash-out refinance can also change the terms or interest rate, but it includes cash back to the homeowner based on the home’s equity.
Within those two basic types of refinance options, conventional mortgages from traditional lenders are the most common. But refinancing can also happen through a number of government programs.
Some, like USDA-backed loans, require the initial mortgage to be a part of the program as well, but others, such as the VA, have a VA-to-VA refinance loan called an interest rate reduction refinance loan and a non-VA loan to a VA-backed refinance, so it’s important to shop around to find the best option.
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How Early Can I Refinance My Home?
If a home purchase comes with immediate equity—it was purchased as a foreclosure or short sale, for example—the temptation to cash out immediately with a refinance may be strong.
The same could be true if interest rates fall dramatically soon after the ink is dry on a mortgage. Especially for conventional loans that are backed by Fannie Mae or Freddie Mac, it may be possible to refinance right away. Others may require a waiting period.
According to credit-reporting company Experian, for example, there can be a six-month waiting period for a cash-out refinance. Or refinancing via government programs like the FHA streamline refinance or VA’s interest rate reduction refinance loan can require waiting periods of 210 days.
Lenders can require a waiting period (also called a “seasoning period”) until they refinance their own loans for a number of reasons, including insurance that the original loan is in good standing.
For a cash-out refinance, some lenders may also require that the home has at least 20% equity.
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Questions to Ask Before You Refinance
As with other things in life, just because you can (refi) doesn’t necessarily mean you should. Before you jump on the refinance bandwagon, ask yourself these questions.
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1. What Is the Goal?
The endgame of a mortgage refinance can help determine whether now is the right time. If a lower monthly payment is the goal, it can be wise to play around with a refinance calculator to see just how much a lower interest rate will help.
For years, it has been a general rule that a refinance should lower the interest rate by at least 2 percentage points to be worth it. Some lenders believe 1 percentage point is still beneficial (each percentage point amounts to roughly $100 a month in payment reduction), but anything less than that and the savings could be eaten up by closing costs.
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2. What Is the Total Repayment Amount?
It’s important to remember that a lower monthly payment—even if it’s significantly less—doesn’t necessarily equal savings in the long run.
If a mortgage with 20 years remaining is refinanced to lower the monthly payment, for example, the most affordable option could be a 30-year mortgage. But is the lower monthly payment worth it if it will be around for 10 additional years?
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3. Will I Need Cash to Close?
One of the biggest differences between a first-time mortgage and a refinance is the amount it costs to close the loan. Many times, closing costs for a refinance can be rolled into the loan, requiring no cash at the outset.
Closing costs typically come in at 2% to 5% of the loan amount, and although they can be rolled into the loan and paid off over time, that could mean the new monthly payment isn’t as low as planned.
One way to make sure the investment is worth the cost is to ask the lender for a break-even period.
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