Over the past year, the average rate on a 30-year fixed mortgage fell from over 5% in November 2018 to under 4% in June 2019, marking the first time rates dropped below 4% since 2017. Mortgage rates are typically pegged to the 10-year Treasury note, so when the yield curve inverted in March and longer-term rates fell, mortgage rates fell as well. This unusual event received plenty of media coverage and perked the ears of current mortgage borrowers nationwide. With rates poised to fall even further possibly, many of you homeowners might be wondering if now is a good time for a mortgage refinance. Reducing the interest rate, adjusting the term, or changing the loan type on your mortgage could potentially save you tens of thousands of dollars over the lifetime of the loan. Yet, securing a new loan can be a tedious, costly, and potentially lengthy process. As a result, you need to understand the options available, the refinancing process, and the associated costs before deciding if a mortgage refinance makes sense for you.
There are four primary mortgage refinance options available, depending on your specific needs and current situation:
- Rate and term refinance
- FHA loan refinance
- Cash-out refinance
- HELOC refinance
We believe a rate and term refinance is the most straightforward type of mortgage refinance. It has the potential to provide an opportunity to lower the interest rate on your loan, change the loan type, or both. An example of changing the loan type could be moving from an adjustable-rate mortgage to a fixed-rate mortgage and either increasing or decreasing the term of the loan (e.g., 15-years to 30-years).
FHA loan refinancing is only available to those of you with existing FHA-insured mortgages, but there can be benefits to this type of refinancing. For one, the process is much more streamlined than others. Providing your FHA is in good standing, this type of mortgage refinance requires minimal documentation and underwriting.
A cash-out refinance allows you to potentially lower the interest rate on your loan while also cashing out some of the equity in your home. The downside to this type of mortgage refinance is a more substantial loan amount and a prolonged loan amortization. However, if you already have a lot of equity and a need to borrow a lot of cash (typically at least $50k or more), this is undoubtedly a cheaper option than a personal loan. When pursuing this refinance, you never want to exceed more than a 60% loan balance-to-home value ratio, and you’ll need a good credit score (typically above 740) to qualify.
Lastly, a HELOC refinance is for those of you that have a separate home equity line of credit (HELOC). HELOC’s work a lot like credit cards – they allow you to borrow up to a certain percentage of the loan to value ratio in your home (typically 80%, but it varies by state and lender) and then spend against it as you need or wish. Most HELOC’s are variable rates, and they have two phases: the draw period followed by the repayment period. During the draw period (typically 10 years) you can borrow from the credit line by checkbook or card and the minimum payments are usually interest-only.
After the draw period is the repayment period. At this point, you are no longer able to borrow against the credit line, and you must make monthly payments that include both principal and interest. HELOC interest rates are often variable, so this type of refinancing would be ideal for wrapping the mortgage loan and the HELOC into one low, fixed rate.
Unfortunately, the mortgage refinance process can be rather cumbersome. The average refinance takes between 20 and 45 days, according to LendingTree, but there are plenty of different variables that can either speed up or slow down the process. Regardless, all refinancing follows a similar process comprised of the following steps:
- Determine the value of your home. Some lenders may require an appraisal for this step.
- Research the different loan options and current interest rates.
- Research any fees and additional costs.
- Gather the required documentation. This will typically include a copy of a pay stub, at least two years of W-2’s and federal tax returns, at least two months of bank statements, a copy of the homeowner’s insurance policy, and a most recent mortgage statement.
- Select a lender and apply for a loan. Fortunately, most lenders allow for online applications these days, making the refinancing process a bit more convenient.
- Receive a loan estimate. The lender will provide an estimate of the total costs of the loan along with other details, such as the monthly payment and the amount of cash that will be needed at closing.
- Loan processing. The lender will inspect and record all the documents you submitted with your loan application.
- Home appraisal. Most lenders (unless it’s a Fannie Mae or Freddie Mac loan) will require a home appraisal to be completed sometime before the loan goes into underwriting. Lenders do this to ensure accuracy in the current value of the home.
- Underwriting. The lender will review all the paperwork involved in the refinancing and make sure everything is in good order. It is common to receive questions or requests for additional information during this step.
The costs associated with a mortgage refinance will vary – often drastically – between lenders and geographical markets. As a result, the most vital piece in this entire process is twofold: 1) Do your homework, and 2) Get familiar with the standard fees involved. Broadly speaking, you can expect to see the following fees:
- Loan application/origination fee. This fee starts the mortgage application process and is typically nonrefundable if you don’t get approved or don’t go through with the loan. The mortgage refinance process costs lenders money, so this fee is more like a “good faith” fee showing legitimate intent. Fortunately, it is often waived once finished with the loan process.
- Loan underwriting fee. This fee covers the cost of having a mortgage underwriter assess your loan-worthiness. It typically costs around 1 percent of the loan amount. Sometimes this fee is combined with the loan origination/application fee.
- Home appraisal fee. Unless you have an FHA loan, most lenders will require you to pay for a home appraisal to confirm the value of your home.
- Title insurance. This is required by all lenders, and it protects buyers and mortgage lenders from any issues that might arise with a title when there is a transfer of property ownership.
- Yield-spread premium. This fee only pertains to those who use a mortgage broker to arrange the financing between you and another lender. The lender pays this fee to the broker, but it is usually passed on to you as a closing cost.
- Credit report fee. It costs money to do a hard pull of your credit and lenders typically pull several different versions, so actual cost can vary.
- Discount points (aka mortgage points). These are used to reduce the interest rate on the loan and are paid to the lender at closing. 1 point is equal to 1 percent of the loan value for every $100k. For example, 2 points on a $500k mortgage would cost an additional $10k at closing in exchange for a lower interest rate.
- Prepayment penalty. This fee only applies if you pay off your mortgage very early on (3-5 years). Not all lenders do it, but some may charge a fee to do so. Hence, if you’re planning to pay your loan off early, make sure you look through the loan documents for any possible prepayment penalties.
The Bottom Line
While interest rates have fallen and an opportunity exists to save a lot of money on your mortgage potentially, this does not immediately signify it’s time for a mortgage refinance. Instead, you should do your homework first. Research your mortgage refinance options, get familiar with the process, and be prepared for all of the associated costs. In general, if the cost savings on the mortgage refinance outweigh the fees and hassle of doing so, then it could certainly make sense. For those of you who have borrowed within the past few months, however, most lenders won’t allow you to refinance within 6 months of issuance.
If you are still unsure if a mortgage refinance makes sense for you, schedule a time to chat with us today to see how we can help!
Forefront Wealth Partners is an independent financial advisory firm that provides creative problem solving to our clients. In a world where change is accelerating and the future uncertain, we provide simplicity and confidence concerning financial, tax, and legal strategies. Our process involves a deep relationship, focusing on meaningful outcomes and dynamic planning.
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