There’s Still Time to Refinance, But Make the Right Decision for the Right Reasons

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Photo: SIphotography - Getty Images

Home refinancing illustration

One advantage to staying home during the pandemic is the amount of money you saved that otherwise would have been spent enjoying life. The fortunate among you have also spent some time appreciating the fact that you have a home and the safety and financial security it provides. For most Americans, home ownership constitutes their most significant financial investment.

A significant number of you are also saving money on yourr home by refinancing your mortgages at lower interest rates. This can be an excellent way to increase your personal income by reducing the cost of monthly payments which, in turn, can add up to significant savings over the life of the mortgage. (I can feel you logging on to your favorite lender websites even as we speak.)

How Does This Work?

All lending starts with the prime rate, defined as the rate commercial banks charge their best corporate customers and based on the Federal Reserve Bank’s overnight rate. The banks also factor in the 10-year Treasury yield, and a few other variables. All mortgages and other loan rates are determined by the prime rate, as well as by the size, purpose and terms of the loan, and the borrower’s creditworthiness. The higher your credit score, the more favorable your loan rates and terms because you’re considered a lower credit risk to the lender.

Since the start of the pandemic, the Fed has worked diligently to keep the prime rate low in hopes of stimulating the financial markets and promoting borrowing, which helps keep money in circulation and the economy flowing. The lower the prime rate, the lower other corresponding loan interest rates. Think of prime as the cost of money if that concept doesn’t seem too obtuse to you.

In late January the Federal Reserve, pleased with the economy’s general strength but concerned with rising inflation, promised there would be hikes in the prime rate, the first of which occurred in March with an increase of .25%. The Fed said there could be as many as 6 rate hikes during 2022 as an effort to stem inflation, which also translates into higher mortgage rates for borrowers. Current rates are historically low, but the cost of money is going to start increasing, albeit slowly. That means 2022 will be a good time to refinance your mortgage, although some economists suggest acting sooner rather than later.

The Whens and Whys of Refi

Remember when you first bought your home? In and among all the excitement there were credit checks, home inspections, loan origination costs, closing costs, and a wide array of other expenses and activities that added to the task of taking legal possession of a property. When you choose to refinance that home’s mortgage, the process is similar, minus the new-home excitement. In essence, you are paying off your original debt on the property and turning right around and rebuying it under new financial terms. Like the Boy Scouts, be prepared.

Processes may differ slightly from lender to lender, but the experts note that closing costs on a mortgage refi can run 3 percent to 6 percent of the loan cost, so you will have to add that to your economic equation to determine if it’s time to refinance. If you’re not planning on living in the house much longer, it’s probably not worth the cost and effort since you may not recoup the money you invested during the refi process. Crunch the numbers—generally done by dividing the closing costs by the amount of money saved each month at the new rate—to determine your breakeven point and how many months you’ll have to live in the house under the new mortgage to make it worthwhile.

Speaking of numbers, while there is some comfort and security refinancing with the same lender who holds your current mortgage, studies have shown that borrowers who get pre-qualified by at least three different lenders—or maybe five if you’re a glutton for punishment—tend to find better rates and have realized greater savings on their monthly mortgage payments. In fact, some research shows the multiple pre-qualifications have saved borrowers between $1,500 -$3,000 over the life of the loan. And isn’t that what this process is all about?

The Cost of Borrowing

Innovative rates and terms from nontraditional lenders have emerged in recent years, but the benchmark for most borrowers and lenders is still the 30-year fixed-rate mortgage, terms that favor most families who plan to live in their homes for a longer duration. According to experts, if you’re a well-qualified owner currently holding a mortgage in the 3% to 3.55% range you’re right about where you should be given the tumultuous financial climate. If you do plan to refi, make sure you can reduce your interest rate by .5% to 1% so you’re sure that all we have discussed thus far is worth the cost and effort.

But there’s another reason to refinance. If you’re doing better financially these days, you may want to consider switching to a 15-year fixed-rate mortgage. The monthly payments will be higher, of course, but you can reduce your interest rate as well as pay off your mortgage sooner, saving considerable funds while securing a lower interest rate in the process. Reducing the overall financial burden is critical and retiring loans of any type—and ending the corresponding interest paid—should be among your primary financial goals.

Act Wisely

We already discussed the need for a good credit rating. But most lenders also require you to have at least a 20% equity ownership in the house and a debt-to-income ratio of between 40% and 50% to make sure you can afford to make the monthly payments while at the same time meeting other existing financial needs in your life. Like, say, food.

Above all, remember that this is purely a financial initiative, and if a refi doesn’t represent a lower monthly mortgage payment and/or a long-term savings in interest payments, then it’s best to walk away from the concept. After all, it’s only money.