5 Reasons Why Spring 2019 Might Be a Good Time to Refinance
News of the death of mortgage refinancing has been greatly exaggerated. Interest rates have now dropped to a 12-month low as of the middle of February 2019, according to Freddie Mac — which may make it worthwhile to look at refinancing if you recently took out a loan.
Adding to the good news for a potential refinance: Home prices are still on the rise. The pace of increases has slowed down, but the combination of lower rates and more equity may make spring 2019 the perfect time to consider a mortgage refinance.
How to determine if a refinance makes sense now
Most people don’t start looking into refinancing until they hear something about lower interest rates on the news, or start getting inundated with refinance offers on the phone and in the mail. The only problem with this approach is that by the time you follow up, those low interest rates may have already gone up.
Three major factors go into your monthly mortgage payment: The total loan amount, the term of the loan (which is how long it will take to pay it off such as 30 years or 15 years) and the interest rate. The higher the interest rate, the more you’ll pay per month.
But if interest rates move lower, that mean you can refinance to get a lower payment, take cash out to pay off high-interest-rate credit cards, or make some home improvements. Sometimes you can accomplish all of these objectives with a refinance — your potential benefit depends on how much equity you have built up in your home, and how high your interest rate was when you took out that mortgage.
In 2019, many assume that because the Federal Reserve has been increasing the federal funds target rate, mortgage rates are just going to continue to go up. While there are usually ties between them, the U.S. Treasury and mortgage markets operate independently of federal funds rate, and an increase in the fed funds rate doesn’t necessarily equate to a rise in interest rates. (The fed funds rate refers to the interest rate banks charge each other to borrow money short-term.) The best example of this is when mortgage rates dropped from 2015 to 2016, at the same time the federal funds rate was being increased.
Still, there is one type of mortgage that is directly and immediately affected by a Fed rate hike — an adjustable rate mortgage — and we’ll discuss the pros and cons of refinancing to a fixed rate a little later in this article.
There are other factors that impact whether rates rise or fall. One big one: the strength of the overall economy.
Rates have fallen over the past year as the prospects for U.S. economic growth weaken, said Tendayi Kapfidze, chief economist for LendingTree. “The lower rates are a welcome development for borrowers who missed the opportunity to refinance before last year’s rate rise,” he said. “Even borrowers who just took out a loan a few months ago may have an opportunity to save.”
With the interest rate market improving for the time being, it may be time to start asking some questions about whether refinancing will improve your financial situation right now.
When did I take out my mortgage?
Rates hit the highest levels in nearly eight years in November 2018, rising all the way to 4.94%, according to Freddie Mac’s Primary Mortgage Market Survey. The surveyed rates are average rates — your rate could have been significantly higher depending on factors such as your down payment, credit score or the type of property you purchased.
There is no general rule of thumb for how long you should wait after you’ve taken out a mortgage. Dropping your rate from 5% to 4.5% on a $400,000 mortgage could save you $120 per month, and some lenders may offer you refinance options with little to no costs if your loan amount is on the higher end of the range.
The other good news? Conventional conforming loan limits went up at the end of 2018, which means you may able to take cash out in a refinance without going into “jumbo loan” amounts with the corresponding extra hoops to jump through for approval.
Have your credit scores risen since you received your last mortgage?
The interest rate you pay is dramatically affected by your FICO scores, especially on conventional loans. The same is true of private mortgage insurance. If your credit score has risen by 20 to 40 points since you took out your current mortgage, it’s worthwhile to take a look at a refinance. You might be eligible for a better rate than you’re currently getting.
It’s important to know your credit score for a home loan, especially if you’re considering a refinance. The benefit of the steps that follow depend on you knowing what your credit score is.
Has your home value risen enough to get rid of your mortgage insurance?
Conventional loans are backed by government sponsored enterprises Fannie Mae and Freddie Mac, and require borrowers to take out mortgage insurance if they make a down payment of less than 20%. However, this mortgage insurance can be removed once you reach 20% equity in the home by a combination of home value appreciation and paying down principal.
The level of mortgage insurance coverage you need influences the monthly cost. The more equity you have, the less mortgage insurance you need to pay.
With home prices continuing to rise, you may have enough equity now to reduce or completely cancel your private mortgage insurance. You can also try contacting your current servicer if you think recent sales of nearby homes show you’ve hit 20% equity and see if they’ll consider removing the mortgage insurance.
Do you need to consolidate some debt or do home improvements or upgrades?
If you’ve been thinking about doing some home improvements, or need to consolidate some debt you’ve incurred getting your home settled after you purchased it, a cash-out refinance might be a more cost effective way to accomplish those goals. This allows you to get a new mortgage with a higher balance than your current loan, getting the balance in cash. Keep in mind that the mortgage interest you incur taking out cash for home improvements may be tax deductible.
One of the biggest financial benefits of owning a home versus renting one is the ability to deduct mortgage interest from your taxable income. Under the new tax laws, you can deduct interest on up to $100,000 of equity taken out to complete home improvements.
Do you want to pay off your loan faster?
If you’re in a situation where your family’s income is growing, it might be worthwhile considering refinancing to a shorter term, like moving from a 30-year to a 15-year mortgage.
While shortening your loan term will likely increase your monthly payment, the amount of interest you’ll save in the long run can be significant. For example, refinancing from a $200,000 30-year loan at 5% to a 15-year fixed loan at 3.75% will reduce the total interest you pay over the life of the loan from $186,511.58 to $61,800.08 — saving you $124,711.50 over the life of the loan.
If you divide the total interest savings by the 15 years you’ll have the loan, you’re saving $8,314.10 in interest every year. Of course it comes at a monthly expense of $380.80 in higher payments since your payment increases from $1073.64 to $1454.44 per month, so you need to make sure you’re comfortable with the payment increase before choosing a shorter term.
Do you currently have an adjustable rate mortgage?
When interest rates start rising on fixed rate mortgages, lenders may suggest taking out an adjustable rate mortgage (ARM). These mortgages feature a period where the rate is fixed, anywhere from one year to 10 years, at a lower rate than the current 30 year fixed rate offerings.
However, once the fixed rate period is up, they can rise by an amount based on the current margin and index you agreed to at the time you took out your loan. Usually there is a maximum your rate can rise after the initial fixed rate period — and a maximum amount it can go up over the life of the loan.
After the initial fixed rate, your rate can adjust every six months to every year depending on the index that you agreed to. The indexes, such as the London Interbank Offered Rate (LIBOR) and the Cost of Funds Index (COFI) are directly tied to Federal funds rate increases.
The good news is, if you just took out an adjustable rate, you probably have some time before your rate increases. However, with rates dropping, you may want to look at how much your payment will increase now, rather than try to guess where interest rates will be in five to seven years.
What you need to know before refinancing
If the answer to any of the above questions was yes, you’ll want to start crunching some numbers to determine if a refinance make sense in your specific situation. First you’ll need to start collecting some data and documents so you can analyze the pros and cons of refinancing now.
Find out what your credit scores are
Credit scores will be one of the biggest drivers of how cost-effective your refinance is. You can fill out an online application with a lender, and they will be able to give you your three credit scores.
Get an idea of what houses are selling for in your neighborhood
The best way to get accurate information regarding house sales is to reach out to the realtor who helped you buy your home. Realtors have access to the most up-to-date data on recent sales in your area, and can give you an idea of what your house might appraise for with something called a comparable market analysis.
A comparable market analysis will look at sales in the recent past (usually three to six months) to give you an idea of where your house might appraise.
Research what interest rates are in your area
Once you have an idea of your credit score and the value of your home, you can start looking at what rates are being offered for your particular scenario. There are a number of online mortgage rate comparison tools that will allow you to search this information, or you can give the loan officer who helped you get your mortgage a call to get some ideas.
Research how much your new mortgage insurance will be
This might be new for you, but as a consumer you can access a mortgage insurance rate finder. You’ll want to make sure you input all of the information requested to get an accurate monthly mortgage insurance quote, including your current credit score, how many people will be on the loan, the state you live in and the type of property you own.
Find out what the closing costs will be
Closing costs can vary significantly from lender to lender. Some lenders offer refinances with no appraisals, while others may offer low documentation refinance options with a lower cost.
Be sure to get the costs from three or four different lenders so you have a rough idea of what the average is for the type of loan you are doing.
Be sure to try different type of lenders — mortgage brokers, mortgage bankers and institutional lenders may offer different options. Some may be more competitive than others in any given week or month.
It’s also important to only compare the lender costs and the interest rate when you are reviewing any lender’s loan estimate. Don’t be tricked into comparing property tax and insurance escrow accounts — the final costs for ongoing expenses related to your property will be the same regardless of the lender you choose.
What are your total expenses now?
Gather up your current mortgage statement, along with any credit card statements for accounts you’re thinking of paying off. If you’re also thinking about doing home improvement, have cost estimates or at least a rough budget of how much you want to spend on them.
Calculating short-term and long-term benefits of the refinance
Now that you’ve got the data you need, it’s time to start looking at the numbers. Here’s an overview of what you’ll be comparing depending on the financial objective of the refinance.
Refinance to save on monthly mortgage payments
If interest rates are lower now than they were when you first took out your loan, you’ll almost certainly have a lower monthly payment. However, you also need to factor in the closing costs of the refinance to see if you’ll actually save money.
For the purposes of these calculations, start by comparing your current mortgage payment — principal and interest, plus your current mortgage insurance — to the projected new payment after refinancing. The difference between your old payment and your new payment represents your monthly savings.
Next, you want to calculate your “cost break-even” point. This is the point where you absorb the costs you will pay to get the monthly savings.
For example, if your closing costs are $2,500 and you are saving $150 per month, dividing $2,500 by $150 gives you 16.67. This means it will take roughly 17 months for you to break-even on the costs you’ll pay to complete the refinance.
There are a number of online mortgage refinance calculators that make this process very simple, as long as you have the data you need to enter ready.
Refinance to save on total monthly expenses
This calculation is similar to the calculations above, except you’ll want to add in the monthly payments for any debt you’re currently paying to your current mortgage payment as a starting point for your calculations.
For example, let’s say you currently have a $200,000 loan balance at a rate of 5%, with a $1,074 per month payment. You want to refinance to a rate of 4.5%, and take out cash to pay off $10,000 worth of credit card balances. Your new principal and interest would be $1064.04, which only saves $9.60 per month from your current payment — but you’d also be paying off the credit card balances.
Your total monthly savings would be about $210 per month — assuming that you spend the same $2,500 on closing costs, your break-even on the costs is a less than 12 months. Debt consolidation calculators come in handy when you’re trying to calculate these figures.
Refinance to pay for home improvements
This one is a little trickier when it comes to calculating the breakeven. You really need to have an idea of other alternatives to finance the home improvement costs to accurately calculated this cost benefit analysis.
For example, let’s say you have a current mortgage of $200,000 at 5%, which gives you a principal and interest payment of $1,074. Assuming current rates have dropped about .75% to 4.25%, and the repairs and improvements are $15,000, your new payment would be $1,058 based on a $215,000 loan amount.
This basically means it would cost you less than $20 per month to finance the costs of the repairs into your mortgage. Of course you are financing the $15,000 over 30 years in this example, so you need to calculate the extra long term interest, and evaluate whether shorter term financing such a personal loan might make more sense.
Refinancing to pay off an adjustable rate mortgage
If you had to take out an adjustable rate mortgage to qualify, or weren’t comfortable with the fixed rates when you took out your current mortgage, you may have an adjustable rate mortgage. Although rates may not have dropped enough for you to save money now, you can at least calculate the difference between what your rate is now, and what it will be if your rate rises by the maximum possible in the future on your ARM loan.
For example, let’s say you decided to take out an adjustable rate mortgage in the week ending Oct. 25, 2018. According to the Freddie Mac rate survey that week, the 5/1 adjustable rate mortgage average was 4.14%, while the 30-year fixed rate was nearly 4.86% for the same week — on a $250,000 mortgage, the difference in payment was approximately $107 per month.
According to the mortgage rate survey, the 30-year rate averaged 4.41% for the week ending March 7, 2019. Using the same $250,000 loan amount, your principal and interest would be $1253.38 per month.
The principal and interest for a 5/1 ARM at $250,000 at 4.14% is $1213.80 per month. That means your payment would go up by $39.58 per month, and you’d probably spend about $2500 in lender and title fees, if you don’t pay any points related to the interest rate.
Now you need to look at the maximum your rate could increase after the initial fixed rate period is over. Let’s assume for the purposes of this that your initial adjustment is capped at 2% every year after the initial fixed rate period, and your first adjustment is capped at 2% with a start rate of 4.14%.
Based on the adjustment, your rate could go up a maximum of 2% to 6.14% after the first adjustment. This assumes the indexes continue to rise over the next five years — the rate could be lower, but it won’t be more than the first year adjustment cap.
The payment at 6.14% on an original balance of $250,000 would be $1521.45 per month — an increase of $307.65 per month. Your big decision is this: do you take the increase of $39.58 per month now to avoid potentially paying $307.65 more per month in a worst case ARM payment in four to five years?
In this example, it makes sense to refinance. As long as you aren’t planning to move or sell your house in the initial fixed period of your ARM, it probably make sense to consider refinancing to a fixed rate.
Pros and cons of refinancing now
With any type of refinance you want to weigh the advantages and disadvantages of refinancing your first mortgage. Then you can decide if you want to get your paperwork together to get the refinance process going.
Pros of refinancing now
A slowing economy could mean lower rates
Bad news for the economy is good news for interest rates. “The economy was always going to slow down, given that much of 2018’s strength was driven by one time unsustainable items like the tax cut,” Kapfidze said. “The question is to what extent the economy will slow — that will determine the rate outlook.”
This shift provides a window of opportunity, but like any financial market, that window could close quickly if the economy starts to strengthen again.
Home prices are still rising
Higher home prices means more equity, which is good for a couple of reasons. First, it gives you access to more equity if you are in a situation where a cash-out refinance will help you with your budget.
The other reason is that it could put you in a position to lower or remove any private mortgage insurance you might be paying if you took out a conventional loan with less than a 20% down payment.
Digital underwriting platforms make it easier to refinance
As more mortgage companies switch to digital mortgage platforms in 2019, the loan approval process becomes more automated and documentation requirements may be significantly reduced. In some cases, you may not need to provide anything more than a completed loan application, and give your lender permission to access all of your banking and IRS income information directly from their databases.
There’s also a chance you won’t need a home appraisal. Fannie Mae and Freddie Mac are offering appraisal waivers on eligible properties, which could save you $300 to $700 in cost, and allow you to complete your refinance without having to spruce up the house for an appraisal inspection.
Cons of refinancing right now
There are also a number of reasons why a refinance might not be the right choice right now. You’ll want to consider these before you make a final decision about refinancing.
The interest rate market is volatile
Rates can rise just as quickly as they go down, so if you’re trying to time the market, be sure you know your tolerance for losses. If the figures make sense where rates are now, the best thing to do is lock in your rate, provide the documents needed to refinance and start enjoying the benefits of the savings.
Your employment situation is changing
If you’re going through a major career change, or are in between positions, now is not the time to refinance your home. If there is a chance you may be relocating, it’s also best to put off refinancing until you know that you’ll be in your current home long enough to break even on the costs of the refinance.
You’re renovating your home
If you’ve already torn out the bathroom or kitchen fixtures and have suddenly realized you need some extra money to subsidize the costs, a refinance loan is not going to work. Lenders won’t lend money if the house is under construction if you want to get the lowest rates and fees.
While a renovation refinance might help in this situation, the extra costs and time it takes to get a renovation loan approved may not be worth it.
Will spring of 2019 be a good time for you to refinance?
Only you can answer this question based on your current financial situation, with all of the information in front of you. There is no hard and fast rule for how long it should take to break even on the costs and savings.
If $50 per month has a meaningful impact on your financial well being, then a refinance make sense. But be forewarned — rates tend to rise faster than they drop, so if your number crunching looks favorable now, lock in and get the refinance completed so you can start saving while this lower rate window is open.
This article contains links to MagnifyMoney, a subsidiary of LendingTree.