When Should I Refinance?

So you’re wondering “when should I refinance?” You hear that your coworker got a great interest rate. You don’t follow the mortgage bond market but occasionally hear those “too good to be true” ads on the radio or television to get a historic low rate with no closing costs. So when does it REALLY make sense to refinance, and how is it possible to do it for no cost? What’s the catch? Whether or not it makes sense to refinance is quite different for each individual’s current loan structure, life plans and financial goals.

The first thing you need to ask yourself is why do you want to refinance or what are some reasons to refinance your mortgage? Here are a few:

• You want to lower your interest rate.
• You want to lower your payment.
• You want to shorten your loan term.
• You want to drop or reduce your monthly PMI payment.
• You want to cash out some equity.

You want to lower your interest rate

If you simply want to lower your rate (the interest portion of each month’s payment), then you need to look at two things; your monthly interest savings by refinancing and the cost to refinance. Once you know this, you need to make a determination if you’re going to keep the new loan long enough to break even to make up your costs. For example, if you are saving $50 per month in interest and the cost is $1,800, it will take you 36 months (3 years of mortgage payments) to break even on your investment. If you know you’re going to keep this loan for more than 3 years. Then YES, it makes sense to refinance because you’ll reach and exceed your breakeven point.

You want to lower your monthly payment

Lowering your rate isn’t the only way to lower your monthly payment. If you want to lower your mortgage payment because of a life situation, it’s not necessarily wrong to refinance to a longer term, even if the interest rate is higher. For example, the principal and interest payment on a 15 Year Fixed $300,000 loan amount at 3.000% is $2,071. However, the payment on a 30 Year Fixed for the same loan amount at 4.000% is $1,432. Let’s face it, sometimes life throws you curveballs and just need to free up some monthly cash, so while paying higher interest isn’t typically viewed as a smart decision, sometimes you need the cash flow.

You want to shorten your loan term

Shortening the term of your mortgage is the fastest way to build equity and a great option for those who can both afford and are comfortable with a higher mortgage payment. Loans that are shorter in term typically have lower interest rates as well. In the example above, a $300,000 loan the payment is $639 higher for a 15 Year Fixed than the 30 Year Fixed. The $2,071 monthly payment doesn’t include your homeowners insurance of property taxes either. So the payment can be quite high relative to that of a loan with a term twice as long.

But how do the life savings compare? The finance charge is the interest/cost over the life of the loan. If you can afford that 15 Year Fixed payment, your finance charges for the loan term is roughly $73,000. The finance charge on the 30 Year Fixed is roughly $215,600. So the savings for the 15 Year Fixed is over $142,000! Makes you consider that higher monthly payment, doesn’t it?

You want to drop or reduce your monthly PMI payment

Another reason people refinance is to drop their monthly Private Mortgage Insurance (PMI) payment. PMI is essentially an insurance premium that you pay, providing some coverage to the banks in case you default on your loan. The cost of your PMI is determined by many risk factors. The PMI factor is higher for somebody at a 95% loan-to-value (LTV) versus a 90% LTV. The factor is reduced even further if you an 85% and then you are eligible to drop your PMI at an 80% LTV.

Keep in mind that the banks will not automatically drop your PMI until you are at 78%, so once you hit 80%, you’ll want to call the loan servicer to see if they’ll remove your PMI. United Home Loans even offers Lender Paid Mortgage Insurance (LPMI). So even if you don’t have 20% equity in your home, you may qualify for loan without monthly PMI. LPMI typically requires you to pay a higher interest rate, but your effective rate could be lower.

For example, if your interest rate is 4.000% and your PMI factor is 0.80%, then your effective rate is actually 4.800%. If you can get an LPMI loan at 4.500%, then your rate is lower than the effective rate of 4.800% when paying monthly PMI. Credit scores and loan term can impact the monthly and LPMI factor and as well.

That being said, if you feel the value of your home has improved enough to lower or eliminate your PMI, your credit scores have improved enough to lower the PMI factor, or you want to explore LPMI, you’ll want to consult with your lender about potentially restructuring your loan.

You want to cash out some equity

I often get calls about cashing out some equity. Whether you need cash for home improvements, your child’s college education or other investment opportunities, cashing out equity from your home may be a good option for you. There are lending guidelines in place that max your cash out on a conventional loan to 80% of the home value and 85% for FHA loans, so typically only people who have a significant amount of equity in their homes are candidates for a cash-out refinance. You can research websites like Zillow to see what homes in your area are selling for. At the end of the day, your home is only valued at what other similar homes to yours are selling for in a couple block radius.

The right time to refinance is really up to you.

I’ve had somebody say “it only makes to refinance if you’re saving a half percent in interest.” I responded with “what if I can drop your interest rate just an eighth of a percent (0.125%) at no cost? Why wouldn’t you?” That person had a very confused look on their face. It’s true. There actually are no cost refinance options.

Without going into how mortgage bonds are traded on Wall Street and how the coupon pricing affects yield spread premiums that translate to discount points and rebates, I’ll keep it simple. Mortgage companies get paid by delivering good loan to the lender that services the loan. They pay companies like us a specific premium for a loan at current market rates. They’ll pay us less money for delivering a loan with a below market rate – That’s typically when you get charged a point, or they’ll pay us more money for a loan delivered at a higher than market rate – That’s when we can provide a rebate to you. Depending on how high the rate is or how large your loan size is (since the premiums we receive are a factor of the loan amount), we may be able to cover a portion of, if not all costs.

Why would you want to take a higher than market rate? Well let’s say you hypothetically have a rate of 4.750%. Market rates are 4.000% with costs of $2,300 or 4.250% with a $2,300 rebate to cover your costs. If you don’t have extra cash available to pay the costs, or you don’t feel you hit your “break even” as discussed above, than 4.250% is great option. It’s truly a no cost loan and saving you half percent in interest. It may not be the lowest rate available, but this makes sense for your financial situation and life plans.

I’m here to provide options

In a market that is always changing, it’s my job to provide options that make sense to YOU. Through knowledge and expertise, I will provide a personalized experience that involves discussing your current financial situation and your various life plans that can affect one of your life’s largest investments – your home. Call me to discuss your current loan structure. If it’s already caters to you perfectly, I’ll tell you that. If there’s something better waiting for you, I’ll provide options.

Written By: Chris Ulrich – United Home Loans
NMLS# 215735