Should I take advantage of low rates and refinance — again?
There are a variety of considerations and few simple answers, but these ideas will help clear away some confusion to help you determine if you should refinance.
First, assess whether or not your home is worth enough to support the mortgage you want
In order to qualify for the lowest cost mortgage, your home should be worth about 1.25 times the mortgage. If you have a $200,000 mortgage, your home must be worth $250,000 to get the lowest cost mortgage in terms of interest rates and fees, including mortgage insurance. Generally, you can’t refinance your mortgage at all unless your home is worth at least 1.11 times the mortgage amount. (In some circumstances you can negotiate with your lender to modify your existing mortgage if the home’s value is lower than the mortgage balance and you have had trouble making the payments.)
In order to get the best mortgage rates, you’ll need to have very good credit
Good credit starts with never making any payments late and includes not having too much debt relative to your income. Recent foreclosures, judgments and bankruptcies make refinancing almost impossible at low market rates. You’ll also need stable income; if you’ve had recent gaps in employment, you may need to wait to refinance. The best way to find out of you have good enough credit is to apply.
The difference between the interest rate you’re paying now and the interest rate you’re being offered is also important. Some lenders will do a mortgage refinance at no charge to you, but they charge a higher-than-market interest rate. This could be a good idea if you plan to move in the near future as you’ll have invested nothing (but your time) in the refinance. If you choose a zero cost refinance deal, any interest savings you get will begin immediately. If you are confident that you’ll be staying in your home for a long time, it may be wiser to pay some fees (typically about 2 percent of the loan balance) to refinance as you should be able to find a lower interest rate than you’d get with a no-fee loan.
If you choose to pay the typical 2 percent fee to get the best rate, you’ll want to make that up as quickly as possible. If your new rate will be two percentage points lower than your old mortgage, that is your old mortgage is at 6 percent and the new one will be at 4 percent or less, then you can make up the cost of the refinance in about a year. If the difference is just one percentage point, it will take about two years. You’ll have to decide what makes sense in your situation, but I wouldn’t refinance to save less than one percentage point.
Keep in mind that there are some things you’ll have to pay at closing that aren’t, strictly speaking, costs of the refinance. Be sure to plan for things like funding the escrow account for property taxes and insurance and for prorated interest at closing. These are all costs associated with having a home and a mortgage and not associated with the transaction, but you may need to pay them sooner than you would otherwise.
Devin Thorpe, husband, father, author of Your Mark On The World and a popular guest speaker, is a Forbes Contributor. Building on a twenty-five year career in finance and entrepreneurship that included $500 million in completed transactions, he now champions social good full time, seeking to help others succeed in their efforts to make the world a better place.