Similar to the stock market, mortgage rates fluctuate daily from Monday through Friday. They can even change during the course of a day in certain circumstances. If you are a homeowner with an existing mortgage, sometime during the course of your loan market forces may drive mortgage rates significantly below your current rate. Similarly, an improved credit score may also qualify you for a lower rate as well.
In these situations, conditions might be ideal to refinance your mortgage. However, it’s not always as simple as saying “hey rates are lower, change my mortgage!” A variety of factors come into play that will determine if you qualify.
Reasons to Refinance
Homeowners refinance their mortgages for different reasons. Most commonly, refinancing at a lower rate can lower your monthly payment. Say you are 5 years into a 30-year mortgage at 5.5%. Refinancing the remaining 25 years at 4% is going to bring down your monthly payment, refinancing the loan at 4% while renewing the original term of 30 years is going to bring it down more still.
Sometimes, homeowners refinance just for a shorter term. A shorter term may automatically have a lower rate, but your monthly payment will increase as you are, say, paying off the remaining loan in 15 years as opposed to 30. However, if you find yourself in the financial situation where you can afford a higher payment, and want to get your house paid off faster, this may be an option for you.
A third reason people refinance is to get cash. If you’ve built up sufficient equity in your home, you can remove a portion of it in the form of cash and add this sum to the new loan. Homeowners can use this money for anything they want. Typical reasons are to make home improvements or to pay off credit card debt.
Whether or not you qualify for mortgage refinancing depends entirely on your home’s equity.
Equity is the fair market value of your house minus what you still owe on the mortgage.
As explained here, when you make monthly payments on your mortgage you are paying two things, the principal and the interest. Let’s say a family gets a mortgage of $200,000 over 30 years at 5.5%. The monthly mortgage payment is $1135. After 5 years of payments the principal has been paid down to $184,633. This family now has $15,367 in equity in their house.
Let’s say in this scenario mortgage rates drop to 4% and the family wants to refinance. Generally speaking, lenders determine if you qualify by looking at the loan to value (LTV) ratio, what you still owe on the home in relation to its value. Again, generally speaking, lenders are typically looking for a loan to value ratio of 80% or lower.
In this case our family’s LTV ratio is 92.32% making it unlikely they would qualify for refinance. The good news is when they applied for new loan their house was reappraised at $250,000, making their LTV now 73.85%, and making them eligible.
Three to six percent of your mortgage refinance will go toward fees. Some of these fees might include application fee, origination fee, appraisal fee, points, inspection fee, closing or attorney review fees, etc. Unless these fees are being paid cash up front, they will need to be tacked on the new loan amount. Let’s split it down the middle and call it 4.5%.
Our family’s balance on their original mortgage was $184,633, add 4.5% closing fees for a total of $8308 and a new loan refinance total of $192,941. At the new APR of 4%, the new monthly payment for the remaining 25 years is $1018, saving the family more than $100 a month. What’s more, if they elect to refinance for the original term of 30 years the monthly payment will be $921.
Either way, even with the associated closing costs, mortgage refinance makes sense and this family qualifies.
The Appraisal Catch-22
Sometimes homeowners initiate the refinance process only to find out after appraisal that their home is less valuable then they thought, their LTV consequently too high, and they don’t qualify for the loan. In these situations, the homeowner still ends up on the hook for the appraisal and application fees, and any other fees associated with the process. So basically they not only fail to refinance but have to pay up too!
Since lenders will usually only deal with their own appraisers, the only solution is to have as accurate and unbiased an idea of the market value of your house. This might mean paying for a third-party appraiser before you begin the mortgage refinance application.