When should I refinance home loans?
Historically low interest rates have prompted many homeowners to once again refinance their mortgage loans to lower their loan payment at little or no cost thereby reducing not only their monthly outflow, but the amount of interest they will pay on the loan over time. If you have 20% equity in your home, stable income and a credit score of 720 or better, you are probably in a great position to refinance. The real question to ask, though, is how a refinance truly benefits your specific financial situation.
Over the last six years, the decline in the market value of real estate has been the primary issue relating to the ability to refinance due to the need for a minimum of 20% equity, as determined by an independent appraisal. For Jumbo rates the equity, or percentage of loan to value required is typically 25%. While Zillow and Trulia can be a good indication of your home’s market value, the appraisal is the only value considered by the lending institution in a refinance. Even with a “no cost” refinance, the appraisal fee is typically paid upfront by you and the amount refunded at closing by the loan broker. It is important then to ask the question, what are my options if my appraisal does not come in high enough to give me the 20% equity? If your refinance is hinging on the right appraised value, and you do not meet it, there are usually three options.
The first option is to pay down your loan to reach the level at which you have 20% equity in your home. For example, if you needed your home to appraise at $250,000 to meet the equity requirement, and it appraised at $230,000, you could contribute $20,000 at escrow to make up the difference. If your intention was to lock in a low long term interest rate and reduce the amount of interest you are paying on the loan over time, this may be your choice.
The second option is to pay Property Mortgage Insurance (PMI), if the loan is eligible and offered by the loan broker, on the gap to the 20% equity. Again, to use the above example, if you needed your home to appraise at $250,000 to meet the equity requirement, and it appraised at $230,000, the gap on which you would pay PMI is $20,000. The PMI will be an amount in addition to your monthly loan payment so if your intention is to reduce your monthly payment, this option may not make sense.
The final option would be to cancel the escrow. At this point, you would be out-of-pocket the appraisal fee and would maintain your current loan rate and terms. Even if you are forced to cancel the escrow, there may be good news on the horizon. Recent sales indicate that home market values are on the rise in many areas of the country. This, coupled with the historically low interest rates, may mean we are headed into a “sweet spot” for home loan refinancing.
** The information provided should not be interpreted as a recommendation, no aspects of your individual financial situation were considered. Always consult a financial professional before implementing any strategies derived from the information above.
When you can improve your cash flow and rates are at least .5% lower than your current rate. A mortgage advisor would be able to run an analysis for you. You can get a recommendation to a mortgage advisor from your financial planner or a friend.
In addition to the traditional answers about when rates are x% lower than what you currently have, I recommend running an analysis showing the impact of sending all the mortgage closing costs in to your current mortgage as a one-time additional principal payment. You may find that it pays the mortgage off in a comparable amount of time as a refinanced mortgage, with a lot less hassle. Of course, if lowering your monthly payment is the primary goal, then a refinance may be better.