Originally published by Natalie Campisi on Bankrate.com.
The average interest rate for 30-year fixed-rate mortgages dropped for the second straight week, falling a combined 12 basis points during the week ending June 10. This gives millions of homeowners a chance to save money by refinancing their loans.
More people have become eligible for refinancing as mortgage rates have steadily moved lower over the past few months. Even a small dip can open the gates for more eligible refinancers.
For approximately 11 million borrowers with a minimum 3.44% interest rate — the current average rate for a 30-year fixed-rate mortgage, according to Bankrate’s national survey of mortgage lenders — refinancing can save them money on their home loan.
Likewise, some 6.5 million borrowers with slightly higher rates (at 3.8%) are refinance-eligible. On the higher side of the rate spectrum, 1 million mortgage holders with rates at 5.4% can save by refinancing.
Why your credit score, income and debt matter
Before you spend the time applying for a mortgage refinance, be sure you check your balance sheet and credit first.
Applying for a refinance is similar to getting a mortgage in that lenders will consider your FICO score, debt-to-income ratio and employment history when evaluating your application. Your interest rate is a reflection of your financial situation, and banks tend to reward low-risk customers with better rates.
Borrowers want to aim for a credit score of more than 740 and a loan-to-value ratio of 75% or lower to nail down the best rates, says Melissa Cohn, executive vice president at Family First Funding LLC in Toms River, New Jersey.
The income needed for a loan is dependent on the bank’s qualifications; for self-employed borrowers, additional proof of income may be required to meet loan prerequisites.
Homeowners who have improved their credit score since getting their original mortgage should see if refinancing makes sense for them.
For every 20-point increase in credit scores, the interest drops about 0.125%. So, if someone had a 680 credit score and now has above a 760, this alone will improve their rate by about 0.5%, says Daniel M. Shlufman, Esq., mortgage banker at Classic Mortgage LLC in Maywood, New Jersey.
For folks who are hoping to lock in a better rate but are not currently financially ready to do so, create a financial game plan now for a better position down the road. This includes paying down debt and saving money for an emergency fund so that credit cards are not the go-to in a pinch.
“Anyone who has owned a home for a modest period of time can attest that unexpected expenses are the rule, not the exception. In addition, life brings its own surprises and added expenses,” says Mark Hamrick, senior economic analyst at Bankrate.
“For young families, that might include the birth of a child and related added expenses. By boosting your own finances, effectively paying yourself, you’ll also be boosting your creditworthiness, which can only help one achieve financial goals overall.”
The best scenarios for refinancing
Falling rates might seem like a money windfall if you have a higher interest rate than what’s available today, but make sure refinancing bolsters your bottom line. Expensive lender fees can actually put you in the red if you decide to refinance and the savings don’t outweigh the expense.
Generally, you need a drop in the rates of 0.5% to 1% (depending on the monthly savings and the closing costs) to justify doing a refinance, Shlufman notes. The rule of thumb is that the savings should be enough to recoup the closing costs within about 18 months to make a refinance justifiable.
“If the closing costs are $3,600, you would need a savings of about $200 per month on the mortgage payment for a refinance to be worthwhile,” Shlufman says. “The larger the loan, the more likely a refinance will make sense since most of the closing costs are fixed (e.g., appraisal fee, recording fees, etc.) while the monthly savings will be much greater.”
If you’re paying PMI, pay attention
Refinancing also makes sense if you have private mortgage insurance, or PMI, and the house value has increased so that there is equity of at least 20%.
Refinancing into a lower rate not only shaves off interest costs but also knocks out monthly PMI payments, which are typically 0.5% to 1% of the total loan on a yearly basis. For borrowers with a $200,000 mortgage and a PMI payment of 1%, for instance, that’s a savings of $2,000 per year or $167 per month.
Federal Housing Administration (FHA) loan borrowers are another group that can potentially benefit from refinancing into a conventional loan. Since PMI is more expensive on FHA loans, those qualified borrowers might save a small mint by reducing or eliminating their FHA PMI and locking in a lower rate, Shlufman says.
Those who want to reduce their terms and go from a 30-year fixed-rate mortgage to a 15-year loan might be able to ax an additional 0.5% from the top since 15-year loans usually have lower rates. That might also mean larger monthly payments, but overall less interest paid over the life of the loan.
Adjustable-rate mortgage holders can also profit from dropping rates; the timing might be right to lock via a fixed-rate mortgage as rates continue to hover around the 4% mark.
Finally, folks hoping to tap their equity while reducing their interest rate can take advantage of cash-out refinances. These are low-interest loans that allow homeowners to borrow against their equity by replacing their existing mortgage with a new loan for a higher amount and receiving the balance in cash. These can be useful for people who want to make home improvements, as the interest is tax-deductible.
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