To refinance, or not to refinance, that is the question.


Thank you for all of your questions and please know this: We hear you. Due to the number of refinancing questions, we decided it would be best to write this blog! If you have any financial questions, please send them through: voice messages, Facebook, Instagram, or Twitter.

The Federal Reserve dropped their interest rates, which means mortgage rates have been falling. The rates may fall even more in the days and weeks ahead. Many people are considering refinancing. Would it be the right move for you? We explain when refinancing makes the most sense.


Everywhere you look, there is so much hype around mortgage refinancing. This interest-rate shifting is in an effort by the Federal Reserve to boost the economy in the middle of the coronavirus or COVID-19 pandemic. I am assuming you've heard of this, unless you live under a rock. Don't get me wrong - Lower interest rates are great, but be careful. How do you know if it’s the right time for you to actually refinance? The rates are low, but it is still worth taking the time to see what’s best for your specific situation. You will sleep much better at night knowing you did you due diligence and made an informed, well-thought-out decisions for you and your family and not just jumping on the refinance hype train.


What Does a Lower Interest Rates Mean for You?

If you were already thinking about refinancing, the low interest rates came at the perfect time. If you can refinance your mortgage and obtain a 1–2% drop in interest rate, that will (1) make a huge difference in your monthly budget, (2) enable you to pay off your mortgage faster, and (3) save you potentially hundreds of thousands of dollars. The other side of this, if you were thinking of refinancing from your current mortgage term down to a 15-year fixed-rate mortgage - now is the prime time to do it. If you want to see the true low interest rate, your best bet is to submit the application instead of the quick online quotes.


Aside from mortgage interest rates being crazy low right now, that doesn’t mean you should roll up all your other consumer debt (credit cards, student loans, etc.) into a refinanced mortgage. This isn't fixing your problem. Just don’t do this. You are just disguising your problem and rolling it into your home. Sure you are paying a lower rate instead of the higher rates that come with credit cards and student loans, but what happens when you charge your cards back up (because you will since you didn't address the root problem) or you buy a new car since you have more room in your monthly budget (because you will since you didn't address the root problem). Lumping your consumer debt (credit cards, student loans, etc.) into your mortgage means it’s going to take a lot more time to pay off those loans and your mortgage too. It puts you even further away from completing either of those goals AND adds extra lifestyle creep risk because you did not fix your problem. No thank you. To fix your problem, you need to get on a written budget, create a financial plan, and attack your debts by paying them off smaller debt balances first (and get energized from those wins). If you need help addressing the root cause of your problem, now is the perfect time to get on a proven financial plan! Stewart Solutions is also offering a FREE Virtual Financial Fitness Session ($100 value).


What Is Refinancing?

Refinancing is the process of getting a new mortgage by changing the terms of the one you already have on your home. You might be thinking of refinancing your mortgage for a few reasons—like taking advantage of lower interest rates, switching mortgage companies, reducing monthly mortgage payments, or using money from the refinance for a big purchase. Don’t worry—refinancing doesn’t mean you end up with two mortgages! Instead, your first loan is technically paid off through the refinancing process and a second loan is created in its place.


How Does Refinancing Work?

To refinance your mortgage, you'll need to shop around (2-3 quotes minimum) and apply for a loan—just like when you applied for your original mortgage. You could contact a lender directly, or use a broker to see if you’re approved and can qualify for refinancing.

To see if you would qualify, you’ll need to dig out some paperwork to make your case. Lenders look for different things, but generally, they want you to meet the following requirements:

  • A Maintained Original Mortgage: Lenders need proof that you’ve maintained and paid your original mortgage for at least 12 months before they’ll consider your loan for refinancing.

  • Equity: You’ll need to show you have at least 10–20% equity in your home.

  • Income: You have to prove you have a regular income, and lenders will also look at your debt-to-income ratio. Basically, they want to make sure you can still pay your bills based on the amount of money you make, and that any existing debt payments you have won’t interfere with your refinanced mortgage payment every month.

  • Credit Status: With lenders who ask for your credit score, having a lower credit score may result in higher interest rates.

But what happens when you don’t have any debt and thus have a nonexistent credit score? Don’t worry! Lenders like Churchill Mortgage will use a manual underwriting process to determine your risk or likelihood of paying your mortgage on time.


When Should You Refinance Your Mortgage?

This ultimately hinges on whether your existing mortgage is less-than-desirable and by refinancing your mortgage (aka new interest rate and terms) it would become a better deal for you. "But how do I know if it is a better deal?" Keep reading.... : )


The easiest way to determine if refinancing gives you a better deal is to calculate a break-even analysis. This will show you whether refinancing is something worth doing in your situation. A break even analysis means running the numbers on whether you’ll be in your home long enough to benefit from the savings that a lower interest rate and payment could bring. It is a pretty simple concept and pretty straight forward. You should also keep in mind and crunch some numbers on how long it’ll take you to make up the closing costs you’ll have to pay for your refinanced mortgage. Yep... remember those? There will be closing costs—we’ll get to them soon! In general, refinancing makes the most sense if you fall into one of these categories:


1. You Have An Adjustable Rate Mortgage (ARM)

This means your interest rates are adjustable, you might start off with the first few years at a fixed rate. But after that, the rate can adjust based on multiple factors like the mortgage market, LIBOR market index, and the rate at which banks themselves lend each other money. Bottom line an ARM can cost you an "arm and a leg!" This is a bad deal and you should refinance into a fixed-rate mortgage.


2. The Length Of Your Mortgage Is Over 15 Years

If your original mortgage is a 30-year term (or more), then refinancing is a good way to get to the ultimate goal of locking in a 15-year fixed-rate mortgage. However, if the interest rate is low enough on a 30-year fixed-rate mortgage to compete with the 15-year rates, then make sure refinancing just to get the shorter term isn’t going to cost you more. You will have to weigh both options (15 vs. 30) depending on the rates. You might be better off on a 30-year mortgage at a lower rate but making extra payments (and committed to making them) in order to pay your mortgage off in 15 years - significantly shortening your payment schedule. Keep in mind, whether you are refinancing or purchasing a house for the first time, your monthly mortgage payment should be no more than 25% of your take-home pay. You want to own your home not your home owning you!


3. You Have a "High" Interest Rate

If your mortgage has a higher interest rate compared to the current market, then refinancing could be a smart financial move if it lowers your interest rate or shortens your payment schedule. The goal is to find a loan that offers a reduction of 1–2% in interest rate. If you are at 4.25% and you can lock in 3.25% then consider it. Conversely, if you are at 4.25% and the refi rate is 3.75%, unlikely a good move depending on your circumstances. Remember, factor in your break-even analysis. The last point is to only refinance if you’re planning to stay in your home for a long time, because it will give you time to make up those closing costs which is calculated in your break-even analysis.


4. Your Second Mortgage (aka HELOC) Is More Than Half Of Your Income

A lot of homeowners with second mortgages want to roll it into a refinance of their first mortgage. Pump the brakes people! If the balance on your second mortgage is less than half of your annual household income, you would be better to just pay it off with the rest of your consumer debt using the debt snowball method. However, if the balance is higher than half of your annual household income, you could refinance your second mortgage along with your first one. This will put you in a stronger position to tackle the other consumer debts. For example, maybe by refinancing you will have more money in your budget to tackle your debt.


Does It Cost Money To Refinance?

You bet. Depending on the lender, your home’s location, and the amount you borrow, closing costs for a refinance can range from 3–6% of the loan amount. I am a CPA, so naturally I am a numbers guy. I like to use numbers in examples to hit home important points. So let's use some easy math to demonstrate this concept.


Your loan amount is $100,000, you could end up paying $3,000-$6,000 in fees at a minimum. This is just the cost of doing business. These refinancing costs typically do not include other costs such as property taxes, mortgage insurance and homeowner’s insurance. Remember, you’re revising the original mortgage, not starting completely from scratch. Refinance closing costs include:

  • Refinance application, a new home appraisal, and title search

  • Home inspection fee

  • Lender’s attorney review fee

  • Origination fee

  • Points fees


While you may not be able to avoid all of these closing costs, you can avoid mortgage points fees by asking for a par quote or zero quote. That means the closing cost estimates will not include points. Okay, so now that you understand all of the associated costs - below is another example to help you calculate your break even analysis.


Let’s say your closing costs will be $4,000 (4%) on a $100,000 refinanced mortgage. Let's also say that you followed our advice and your new refinanced interest rate is 1% lower than your previous rate. That means your annual savings is $1,000 (1% interest rate reduction). If we look at how much that 1% reduction would save you every year, it would take around four years to make up those $4,000 in closing costs - thus 4 years to break-even. Once you’ve made up the closing costs (aka the years after your break-even date), you can enjoy the benefits of the lower interest rates through the end of your mortgage term. Now that you have this figured out, it begs the ultimate question...


Should I Refinance My Mortgage?

You can consider refinancing your mortgage if it (1) locking in a lower rate of interest at a fixed rate or (2) reducing your mortgage term length. The savings you could make from doing it for the reasons we outlined earlier could be used to help tackle the important stuff, like paying down debt or saving for retirement - depending where you're at in your financial journey.


Refinancing is a good idea if it helps you take control of your finances and your monthly bills. You will feel more confident going forward with your financial plan if you have more money to put toward becoming totally debt-free. Plus, just imagine if you owned your home and did not have a mortgage payment - wow! Talk about building wealth.

   

This all sounds great, but there are times when refinancing your mortgage would not be a good idea. It would not be a good idea to refinance (and get into more debt) because you want to buy a new car, remodel your house, take a vacation, or the popular reason...pay off your high interest credit cards. These are all bad reasons to refinance. Reducing your home equity to buy new stuff or to pay off debt puts your home at risk and like I said earlier - it does not address the problem. Just remember, you are not alone and we’re here to help.


If you’re currently out of work because of the coronavirus and finding it difficult to pay your mortgage, there’s good news for you. Depending on your specific situation, you may be able to have your mortgage payments lowered or put on hold for the next 12 months. That can really help to free up the burden you might be feeling right now if you’re concerned about when you’ll see your next paycheck.


So, Are You Ready To Refinance?

To recap, refinancing your mortgage is worth it if you (1) plan to stay in your home for a long time (2) you can save 1-2% on your interest rate, and (3) your break-even analysis is worth paying the closing costs. If you’re ready to refinance, get with a home loan specialist at Churchill Mortgage. They’ll help you get a mortgage you won’t regret!

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