by Nancy Osborne, COO of ERATE
The average homeowner will keep any given mortgage seven years or less before moving or refinancing. In a declining interest rate environment, that holding period for the loan would decrease even more. There was a time when experts advised a homeowner not to refinance unless they could improve their current rate by a minimum of 2%. This thinking was common at the time because of the closing costs required in refinancing a mortgage. However with the advent of zero point and no cost loans (aka no point, no fee loans) the 2% formula no longer applied. It’s important to note that interest rates and points are inversely related, basically the greater the points paid at closing, the lower the interest rate: paying points and fees essentially means you are buying the interest rate down.
It may be a good idea to refinance if…..
- You can improve your rate at no cost. The no point, no fee loan has been a popular option in the refinance markets of the past 15+ years. If your mortgage is large enough to qualify for such a loan and you are not too far into your current loan term, this could be a no brainer for you if you are reducing your rate and (even better) your loan term as well.
- You need to tap into your home equity and you have a good reason for doing so. Your home is not a cash register and should never be treated as such, particularly for frivolous consumer purchases. However there are many good uses for home equity, such examples include making home improvements and funding education expenses. It may make sense to use your home equity to fund big ticket acquisitions such as new cars and other durable goods which may not be tax deductible purchases without using your home as the financing vehicle.
- You have a balloon payment looming on the horizon. Of course if you don’t have any other means to cover the debt this could be a catastrophic event without the option of using your home equity to help covert the debt into a more conventional and manageable one.
- You have an adjustable rate mortgage which is about to spike up. It could make sense to convert the loan to a fixed rate assuming the closing costs are not too steep and you are not planning to move or sell the property anytime soon.
- You have an adjustable rate mortgage that rattles your nerves and keeps you awake at night. If you are the nervous type who can’t handle the uncertainty of a changing adjustable rate index, then you may want to consider refinancing to preserve your nerves and your sanity. Of course if you have distaste for unknown variables, perhaps an adjustable rate mortgage was the wrong choice in the first place.
You may want to pass on refinancing if:
- You are facing a pre-payment penalty on your current loan. The typical pre-payment penalty consists of the greater of 6 months interest or 2 points (which is basically 2% of your loan amount). Shockingly many borrowers who have pre-payment penalties on their mortgage are unaware of it. However most loans that have pre-payment penalties require separate riders or disclosures attached to the mortgage note to serve as an added notice that a pre-payment penalty exists. If you are unsure or question whether your current loan has a pre-payment penalty, check with your loan officer or agent and more importantly check your copies of your loan documents. Always read what you sign at the title or escrow company. Yes there is a lot of paperwork but you can ask for copies from your loan or escrow officer in advance of your loan document signing appointment so you can read them at your leisure.
- You’ve already held onto the loan for some time now. If you are already 10 to 20 years into a 30 year mortgage then a sizeable portion of your payment is now being applied towards principal rather than interest. If you opted to refinance now to obtain a lower rate, but would re-extend the term, it would likely cost you more in the long run.
- Your credit score or overall credit rating has taken a hit. If you have had any recent delinquent or derogatory credit or have had the misfortune of missing an auto or mortgage payment (or worse yet have declared bankruptcy) then your credit might not permit you to obtain the best market rate and you might be better off holding onto the loan you already have.
- You’ve maxed out on home equity loans and lines of credit and have squeezed as much cash from your house as possible. If this scenario sounds familiar then you may not have sufficient equity left to make it worthwhile to refinance at a low rate as most lenders require that you have 20% equity for a no-cash refinance and at least 25% to take cash out to receive the best rate and terms.
Nancy Osborne has had experience in the mortgage business for over 20 years and is a founder of both ERATE, where she is currently the COO and Progressive Capital Funding, where she served as President. She has held real estate licenses in several states and has received both the national Certified Mortgage Consultant and Certified Residential Mortgage Specialist designations. Ms. Osborne is also a primary contributing writer and content developer for ERATE.
"I am addicted to Bloomberg TV" says Nancy.