With interest rates lower than ever, there is lots of talk about refinancing. It feels like I am constantly seeing ads mentioning low-costs, APRs, interest rates and points. Well, what does it all mean?
First, let’s define some commonly used terms:
- Mortgage Term: This is the length of time you will make payments on your loan. For example, a 15-year term or 30-year term.
- Mortgage Rate: This is the percentage you pay in interest on your loan. Obviously, the lower the better.
- APR or Annual Percentage Rate: APR is often used interchangeable with interest rate, but they’re definitely not the same. APR is your interest rate plus any applicable fees and closing costs associated with the loan. Next to interest rate, APR will always be the higher number. When shopping around for a mortgage (or when refinancing), you should focus on finding a lender that offers the lowest APR on comparable rates for the same loan.
- Points: In the mortgage world, points are fees paid directly to the lender at closing in exchange for a reduced interest rate. This is often called “buying down the rate” since it can lower your monthly mortgage payments. One point costs 1% of your mortgage amount. You’ll want to understand all fees (points and otherwise) that are required when closing on a loan.
Now, let’s discuss the important questions and considerations you need to be aware of.
What do I need to qualify for a refinance? Each lender has their own standards and requirements, but generally they’ll look at a few factors:
- Credit score: The lender will want to get a picture of your credit score to understand the risk they are taking when lending you money. In simple terms, the higher the credit score, the lower the interest rate you will qualify for.
- Debt-to-income ratio: This ratio gives the lender an idea of how much of your money goes to regular, recurring expenses. If you have a high debt-to-income ratio, you’re less likely to have large savings and more likely to miss a mortgage payment. If you have a low debt-to-income ratio, the lender is generally more confident in your ability to pay the loan.
- Home equity: This is the percentage of your loan principal that you have already paid off. Most lenders will require that you have at least some equity in your home before you can refinance. Some lenders only require 6-months of mortgage payments, others might require more.
How will this refinance affect my monthly payment? The type of refinance you choose will impact your monthly mortgage payment. If you transition to a lower APR, and keep the same term, your monthly payment will go down. However, if you go to a longer term at the same APR, you’ll pay more in interest over time. If you refinance to a shorter term, your monthly payment will increase, but you’ll own your home sooner. Cash-out refinances (when you take equity out of your home), usually leads to higher payments. Given all the options, it is critical to talk to your lender about how the refinance will impact your monthly payments.
What types of closing costs can I expect? Refinancing comes with a cost. The specifics of the cost will depend on the lender, so it is important to shop around. Be sure to ask your lender for the all-in costs, as mortgage companies have gotten creative with hidden fees. I advise people to think through the break even point of the mortgage to determine if it makes sense for them. For example, if refinancing costs $2,000, but will lower your monthly payment by $100, that means it will take 20 months to break even ($100 x 20 months = $2,000). If you don’t plan to stay in your home for an additional 20 months, refinancing might not make sense. If you do plan to stay in your house for longer than 20 months, it might be a great way to save money in the long term.
Will you sell my loan? Many mortgage lenders sell the loans they close on to other mortgage lenders. If your loan is sold, you’ll need to adjust where you make your payments to, which at times can be a bit frustrating. You should work with your refinance lender to understand who will service the loan in case you have questions or concerns. This will make it easier for you to get in touch with your lender.
Remember, with mortgages, most of the details are negotiable. The term of the loan doesn’t need to be 10, 15 or 30 years (yes, 28 years is an option!). Fees are absolutely negotiable so it pays to shop around!
Mortgage rates today provide an unbelievable opportunity to homeowners. Be sure to do your homework and ask the right questions!