By Holden Lewis
While you’ve been preoccupied with a plague and politics, mortgage rates have been falling and refinances have been booming. And the boom has a lot of room to expand.
Almost 18 million homeowners could cut their mortgage’s interest rate by 0.75% or more, according to Black Knight, a mortgage analytics company. That transcends the 3 million homeowners who refinanced in the first half of 2020.
Mortgage rates dipped to record low territory this summer and fall. The average interest rate on the 30-year fixed-rate mortgage has been under 3% since early September, according to NerdWallet’s daily rate survey.
Not sure if now is the time to refinance? Quiet your confusion by asking yourself the following four questions.
1. What’s my goal?
What do you hope to accomplish by refinancing? The answer to that question is your goal. Identifying your goal is the first step because it points you toward the right refinance loan.
Here are three common refinancing goals:
To reduce the monthly payment. For this simple refinance, apply for a loan of the same term — another 30-year loan, if that’s what you have.
To pay less interest. When you refinance a 30-year mortgage into a loan with shorter term, your monthly payments are likely to be higher, but you’ll pay less interest over the life of the loan.
To get cash. A cash-out refinance allows you to borrow more than you currently owe and take the difference in cash. It’s a common way to pay for home renovations.
2. Is my goal in reach?
Once you’ve identified your goal, you need to figure out if it’s realistic. The right follow-up question will help.
If the goal is a smaller monthly payment: How long will I remain in the home?
The answer matters because when refinancing, you’ll lose money if you sell the home before reaching the break-even point.
Here’s why: When you refinance, you pay hundreds (or thousands) of dollars in closing costs. You want to keep the loan long enough for the savings to exceed those costs. That often takes a few years. You can estimate your break-even period using NerdWallet’s refinance calculator .
If the goal is to pay less interest: Are the long-term savings worth the bigger payment?
If you shorten the loan term, you’ll probably end up with a higher monthly payment. What happens if you have a financial emergency? Will you still be able to make the monthly payment?
If you have doubts, it might be better to refinance for the same term as the current mortgage instead of a shorter one and pay extra principal each month. You’ll still pay it off more quickly, but you can stop making the extra payments when money is tight.
If the goal is to get cash: Do I have enough equity?
In most cases, you’ll be able to borrow up to 80% of your home’s value. This means that if you currently owe 70% of the home’s value, you’ll be able to cash out 10% of it.
Determine your home’s current value and multiply it by 0.8. That’s roughly the amount you’ll be able to borrow. Ask your lender how much you owe on the mortgage right now (or check a recent statement). You’ll be able to cash out the difference between what you owe and 80% of the home’s value.
3. How will the new refinancing fee affect me?
The refinancing door remains open despite an “ adverse market refinance fee ” imposed by Fannie Mae and Freddie Mac that takes effect Dec. 1 and effectively raises interest rates on refinances by about one-eighth of a percentage point. While annoying, the fee is too small to erase the savings that most people would realize by refinancing.
The adverse market refinance fee doesn’t apply to every loan. It applies only to conventional mortgages. If you’re refinancing into a jumbo loan, or a mortgage backed by the FHA (Federal Housing Administration), VA (Department of Veterans Affairs) or USDA (Department of Agriculture), the fee won’t be imposed. Those types of loans accounted for about one-third of mortgages in the second quarter of 2020.
The other two-thirds of mortgages were securitized by Fannie Mae /zigman2/quotes/208846331/delayed FNMA -0.54% and Freddie Mac /zigman2/quotes/202741363/delayed FMCC -0.56% , and the fee does apply to those. There are a few exceptions: The fee won’t be imposed on refinances of $125,000 or less, construction-to-permanent loans, or HomeReady and Home Possible mortgages, which have income limits.
The fee is paid to Fannie and Freddie by the lender, and is unlikely to appear on your Loan Estimate paperwork. Instead, it will probably be included in your interest rate. A 0.5% fee translates into an interest rate increase of about one-eighth of a percentage point.
If you’re refinancing to reduce your monthly payment, the adverse market refinance fee matters because the higher interest rate will push the break-even point back a few months.
When you refinance for a shorter term, the savings on interest quickly overshadows the slightly higher rate.
And if you’re going for a cash-out refi, the goal is to get cash and not to save money, so the fee is irrelevant to your decision.
4. Can I reach my goal some other way?
Reducing your mortgage interest rate may feel worthy of a humblebrag, but there might be other ways to accomplish your goal if you’re unable or unwilling to refinance.
To cut your monthly house payment without refinancing, you could shop for less expensive homeowners insurance.
To pay less interest over time without refinancing, you could pay extra principal every month. By doing so, you would hasten the payoff date, reducing the total interest paid on the loan.
Instead of doing a cash-out refinance, you could keep your mortgage and get a home equity line of credit or home equity loan instead. These loan products often have higher interest rates than you can get with a cash-out refi, but you have the option of paying them off sooner than required.
Whether you refinance or not, the first step is figuring out your goal. Once that’s identified, you can proceed more confidently toward the best decision for you.
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Holden Lewis is a writer at NerdWallet. Email: email@example.com. Twitter: @HoldenL.