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It may come as a surprise that roughly 40 percent of current industry loan volume is coming from refinances. Orion's brokers know that for some, refinancing can lower their monthly mortgage payment and reduce the total amount of interest that your client will pay on their home. Interest rates are no longer at an all-time low, but there are borrowers out there with 7.5 percent mortgage rates, or above, who could benefit. But think about the rate that credit cards charge their customers! It may seem like a no-brainer to refinance. But before your client jumps on the "refi" bandwagon to secure a new loan for your home, you should teach them the pros and cons, as there are some situations when refinancing might not be worth it.
Refinancing a mortgage involves replacing your existing home loan with a new one. Many homeowners choose to refinance to secure a lower interest rate, reduce their monthly mortgage payments, or access their home's equity. Some may refinance to pay off their loan more quickly, eliminate FHA mortgage insurance, or switch from an adjustable-rate mortgage to a fixed-rate mortgage.
Let's explore some essential initial considerations for refinancing a mortgage and then walk through the refinancing process step by step.
When you buy a home, you typically finance it with a mortgage. The lender provides the funds to the home seller, and you repay the lender, usually through monthly payments. Mortgage refinancing involves obtaining a new mortgage to replace your existing one. Instead of the lender paying the home’s seller, the new loan pays off the balance of your current mortgage. You will then repay the lender based on the terms of your new mortgage refinance agreement.
The process of mortgage refinancing is similar to that of securing a purchase mortgage. It requires filing a loan application, undergoing the underwriting process, and closing the deal. Homeowners often refinance to secure a lower interest rate, reduce their monthly mortgage payment, or tap into their home’s equity. Some choose mortgage refinancing to eliminate mortgage insurance or switch from an adjustable-rate mortgage to a fixed-rate mortgage.
Mortgage refinancing can be a strategic financial move, especially if it aligns with your financial goals. It's important to consider the closing costs and other expenses involved in mortgage refinancing. If the potential savings from a lower interest rate or reduced monthly payments outweigh these costs, mortgage refinancing could be a beneficial decision. Additionally, using a mortgage refinance calculator can help you estimate your potential monthly savings and determine if refinancing is the right choice for you.
A lower interest rate for your client's overall debt situation. Borrowers may very well have a low rate on their home loan, probably less than 4 or 5 percent. You'll just have to help them take into consideration how much it costs to refinance, and how long it will take to recoup the costs. If the savings outweigh the costs, refinancing from 4 percent to 7 percent won't save the homeowner any money. Scoring a lower interest rate is a great reason to refinance, but for a higher rate?
Depending on your client's financial situation, refinancing to adjust the length of their mortgage and in effect, monthly payments, could offer significant benefits if there finance pulls “cash out” out of a home that has equity and the money is used to pay off 20 or 30 percent credit cards. Just like paying off credit card debt in one year versus five years, shortening the loan term means they will payless total interest on the mortgage.
On the other end of the spectrum, if they're having trouble making payments and are looking for a way to reduce their monthly payments, refinancing could help with that, too. You could help them go from a 15-year mortgage, for example, to a 30-yearterm and thereby lower the amount that needs to be paid per month. Some borrowers will move from an adjustable-rate mortgage to the stability of a fixed-rate loan.
Simply put: If mortgage rates are lower now than they were when you bought your house, a refinance could save you money — and that’s when it makes the most sense. With a lower interest rate, your monthly mortgage payment will be lower.
Conversely, even if you intend to refinance for another reason — such as to get rid of your FHA mortgage insurance premium — you’ll want to do some math if rates have gone up since you bought your home. Depending on how much rates have increased, you may be better off sticking with your original mortgage.
Mortgage rates fluctuate with market forces, so you can’t control when the rates go down. However, some factors within your control — like your credit score — impact the rates lenders offer you. So if your credit score is better now than when you bought your house, that’s another way you can potentially refinance to a lower rate.
Here are some typical scenarios where refinancing might be beneficial.
If your aim is to reduce your monthly expenses, refinancing into a loan with a lower interest rate can help achieve this. A rate and term refinance is ideal for this purpose.
Refinancing to a shorter loan term, such as moving from a 30-year mortgage to a 15-year loan, reduces the interest paid over the life of the loan, though it usually increases monthly payments. If you want to pay off your loan faster but interest rates have risen, consider making additional payments on your current loan.
Alternatively, you can extend the loan term — for example, from 15 years to 30 years — to lower your monthly payment. However, this means taking longer to pay off your house and incurring more interest over time. Explore other options to lower your monthly mortgage payment if you're experiencing financial difficulties, and weigh the pros and cons before opting for a longer term. Keep in mind that if current rates are higher than when you initially purchased your home, your savings might be affected.
If you refinance for more than your current loan balance, the lender provides you with the difference as cash. This is known as a cash-out refinance. Depending on your credit score and the rates at the time of refinancing, you might secure a cash-out refinance with a lower interest rate.
If refinance rates aren't favorable when you want to tap into equity, consider a home equity line of credit (HELOC). This option allows you to draw on your home equity as needed and repay it similarly to a credit card.
While private mortgage insurance on conventional loans can be canceled, the Federal Housing Administration mortgage insurance premium on FHA loans often cannot. If your FHA mortgage insurance premiums are set for the life of the loan, you can eliminate them by refinancing to a conventional loan once you've built at least 20% equity. To calculate your home equity, estimate your home value and subtract your mortgage balance.
Interest rates on adjustable-rate mortgages can rise over time, while fixed-rate loans remain constant. Refinancing from an ARM to a fixed-rate loan offers financial stability if you prefer predictable payments.
Source: Citizens Bank
Refinancing a mortgage involves several expenses that borrowers need to consider. These costs can vary depending on the lender, the loan amount, and the location of the property. Generally, refinancing costs can range from 2% to 5% of the loan amount. Here are some common fees associated with refinancing:
Let's say you want to refinance a $200,000 mortgage. Here's a breakdown of potential costs:
Total Refinancing Costs: $3,700
In this example, the total cost to refinance would be $3,700. It's essential to compare these costs with the potential savings from a lower interest rate or reduced monthly payments to determine if refinancing if right for you.
Brokers know, however, like most things that seem too good to be true, there are some pitfalls. The biggest is your client will have to pay closing costs, which most view in their minds as the amount it costs to refinance a home. According to the Federal Reserve, closing costs can add up to 3 to 6 percent of the outstanding principal of a loan, and include application fees, loan origination fees, and appraisal fees, among other things. The costs add up, but if you calculate that their savings from refinancing will outweigh these closing costs, then you've added value. Just make sure to do your due diligence and help them consider their options wisely.
Secondly, if your client will move in a few months, or even a year after refinancing, the costs of refinancing may be greater than the total savings. One rule of thumb is that if they're not going to recapture the closing costs within two years, it's not worth it to refinance.
The final consideration is to make sure that the borrower chooses a broker ally for doing the loan. If their credit score is lower now than when they initially took out their mortgage, they may have to pay a higher interest rate, which may defeat the whole purpose of refinancing. Brokers will also compare the amount of the loan request to the value of the home and if the loan-to-value (LTV) ratio does not fall within lending guidelines, question the viability of the loan, or spend the time to restructure it. So, help your client decide to take the plunge and refinance, as it's important to figure out if they'll truly be able to reap the benefits of refinancing.
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