Is Refinancing a Good Idea?
The fast spread of the coronavirus left the financial markets on the edge. The whole world feels the unsteadiness of the market and economic threats caused by the pandemic. In March, the Federal Reserve dropped the interest rates to zero and bought at least $100 billion in government and mortgage-related bonds. This move is a part of wide-ranging emergency action. An effort to protect the economy from the COVID19 outbreak. In addition, this move aims to stabilize financial markets and make borrowing costs low. Right now, the interest rate ranges are down to 0 to 0.25% from 1 to .25%. If the low-interest rate continues, it will entice borrowers to consider refinancing and lock in the low rates. In these times of pandemic, is refinancing a good idea?
COVID19 pandemic created a big impact on real estate investing. Even the real estate lending felt its effects.
What is Refinancing?
Refinancing is a major financial decision where a borrower uses a new loan to pay off his existing mortgage loan. Most borrowers consider refinancing to:
- Get a lower interest rate
- Shorten mortgage terms
- Change the type of their mortgage
- Consolidate their debt
- Get cash with cash-out refinance
By refinancing, borrowers can achieve the goals mentioned above and give them more financing options. While these goals are enticing, doing so is not an easy decision. Refinancing attracts more borrowers due to the potential savings that come with it. However, it may not always be the best option. Before refinancing, you need to do your research first. Assess your situation and needs. Only then you can decide whether refinancing your mortgage is the best option.
When is Refinancing a Good Idea?
How will you know if refinancing your mortgage will be worth it? Refinancing is ideal if the current interest rates are at least 1% lower than your current rate. In this way, you can determine how much savings you can get. Aside from that, refinancing will also be worth it if you plan on staying in your home for another five years or more. Why? It will give you little time to recoup the costs. Before you can finalize a new loan, there are closings costs associated with it. Application fee, appraisal fee, inspection fee, title search and insurance fee, to name a few. Because of these fees, you need to calculate how long you will need to pay your new mortgage until when you plan to sell.
How to Calculate the Potential Savings from Refinancing?
There are refinance calculators available online like the Bank of America Mortgage Refinance Calculator. But to clearly illustrate, I will provide an example.
Let us say your current loan is a 30-year mortgage loan at a fixed interest rate of 6% for $150,000. Every month, you are paying $899. If we will do the math, you will pay $323,755 throughout the life of the loan, including $173,755 in interest. After five years, the total payment amount you have made is $10,418 principal and $43,541 in interest. That leaves you a principal balance of $139,581. You then decided to refinance the balance with a new 30-year fixed-rate loan of 4.5%. Using the mortgage refinance calculator, you will easily see the difference with the new loan.
The new loan will slash your monthly mortgage payment from $899 to $707. Over the life of the loan, you will only pay $254,605, of which $115,024 is interest. Add in the $53,959 in principal and interest you paid in five years on the previous mortgage. This will bring a total cost of $308,564 — including $158,565 in interest.
In this example, you were able to lower your monthly payments significantly; and will get a long-term savings of $15,190 in interest.
Is Refinancing a Good Idea? Pros and Cons
As mentioned above, you need to carefully assess your situation and needs before considering refinancing. There are pros and cons in doing so. Here are some of them:
Pros
- Lowers down monthly payment
- Possible reduction in overall interest payments
- You can save money
- You can get cash to pay for home improvements and other purchases
Cons
- The loan term will reset
- By resetting the term, you will most likely pay more in total interest
- If the loan is just a few years old, refinancing will counterfeit savings
- Reducing loan term when refinancing means higher payment
Refinancing is financial move that is not applicable for everyone. Do not do it just for the sake of doing it. There are things to consider when refinancing.
Things to Consider When Refinancing Mortgage
Home Equity
The current value of your home plays an important role in refinancing. It will determine if you are eligible or not. Typically, refinancing process involves an appraisal of your home. It is where an independent party will do a walk-through of your home and determine its market value. For you to qualify, the loan-to-home value ratio should not be more than 80%. If your home’s value went down since you bought it, you might not have enough equity built up to refinance. In that case, you might need to bring cash to closing to offset the difference between the value of your home and the amount of the loan.
Credit Score
The demand for refinancing increases especially when rates are at lowest. Thus, lenders have strengthened their guidelines and requirements in loan approvals. Typically, lenders require credit score of 760 or higher for borrowers to qualify for the lowest mortgage interest rates. Other financial institution such as JP Morgan Chase did the same. They will now require new mortgage applicants a minimum FICO credit score of 700 and they will need to make at least a 20% down payment on the home.
Closing Costs
The total amount of fees associated with refinancing can really be high. Normally between 3-6% of the total loan amount. Before refinancing, make sure the costs will not neutralize the savings you can get from refinancing. Though some lenders offer a “no cost” refinance but comes with a higher interest rate.
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