2020 was an unprecedented year in many respects, and the record-setting rate of mortgage refinances is no exception. Not only did more borrowers seek to refinance their mortgages, but lenders made an increased profit on each loan.1 Some analysts predict that these lenders will be forced to lower their rates in 2021, as this crush of refinancing borrowers finish moving through the pipeline. Below is an overview on when refinancing is worth it, as well as a few factors to consider when choosing a refinance lender.
Is Refinancing Worth It?
Generally, refinancing is worthwhile when it lowers your interest rate, shortens your term, or both—as long as the fees and costs of refinancing allow you to reach a break-even point before you plan to sell the property. If, for example, it will take you around seven years of lower payments to recoup the costs of refinancing and you’re hoping to sell the property in the next five years, refinancing isn’t a good use of your time or money.
In certain situations, refinancing can also reduce your monthly payment, sometimes by extending the term. This is an ideal situation for when you need to free up extra funds. If you are looking to take advantage of a portion of your home equity, you also can pursue a cash-out refinance. This will increase the amount of your mortgage and allows you to receive cash at closing.
With today’s low interest rates, almost every property owner who hasn’t already refinanced or taken out a new loan within the last few years can receive a lower interest rate by refinancing. If you’re still deciding whether refinancing is a good choice, there are a number of online calculators that can help you estimate your new loan payment based on factors like the term of the loan, your taxes and insurance payments, and even your geographical area (as interest rates, terms, and fees can vary in different parts of the U.S.).
Factors to Consider When Choosing a Lender
In the past, refinancing meant going to your local bank and making a handshake deal. However, today’s broader availability of mortgage lenders, including online lenders, means that you can refinance your mortgage without ever leaving your home.
When comparing loan options, there are a few factors you’ll want to consider in addition to the interest rate:
- The lender’s reputation and customer reviews
- The fees associated with refinancing
- The loan products available (including adjustable-rate and fixed-rate mortgages, 15-, 20-, and 30-year mortgages, and FHA, VA, and USDA loans)
- Whether the refinance process can be started (or completed) online
- What loan-to-value (LTV) ratio the lender accepts
- What credit data is considered
- Whether the lender has a physical presence in your area
- Whether the lender offers discounts or a more competitive rate to those who have other accounts with it; and
- Whether the lender plans to sell the loan after refinancing (more common among larger lenders and internet-based lenders).
Factors the Lender Will Consider When Extending Credit
Along with making sure the lender is a good fit for you, consider if you’re a good fit for the lender. Lenders tend to consider three main factors when evaluating a borrower’s refinance application: (1) the borrower’s credit score; (2) the borrower’s DTI ratio; and (3) the average loan-to-value (LTV) ratio.
The DTI ratio is calculated by dividing all your monthly debt payments by your gross monthly income. If this ratio is too high, the lender may decide you’re not a good credit risk and could decline to offer a loan.2 It is important to note that the typical cutoff ratio is around 40 to 50 percent. However, in some cases, a high DTI ratio can be offset by a lower LTV ratio, a high credit score, or other creditworthiness factors.
The LTV ratio divides the amount of your loan, or the amount you’d like to take out, by your home’s appraised value. To avoid repeating the mistakes of the Great Recession, lenders generally require borrowers to have an LTV ratio of at least 80 percent (or 20 percent equity in the property), which helps ensure that, even if the property value drops, some equity remains.3
Future mortgage rates are always a perplexity, particularly in these unprecedented times. Will the economic turmoil associated with the COVID-19 pandemic spur the Fed to keep interest rates low for the foreseeable future? Or will an economic stimulus lead to rising interest rates over the next few years? Just as attempting to time the stock market can sometimes lead to lost profits, attempting to time a refinance to capture the lowest possible interest rate can be an exercise in frustration. Instead of chasing interest rates, consider the above factors to help you decide how to proceed.
1 https://www.bankrate.com/mortgages/treasury-versus-mortgage-rates/
3 https://www.transunion.com/blog/home-buying/how-much-equity-do-i-need-to-refinance
