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When to refinance your mortgage: complete guide


As a homeowner, we are sure that you know that the mortgage is your most significant monthly expense. If you have capital in your home, then you may be thinking about refinancing to help you get a better financial position.

However, do you have any idea when is a good time to refinance? There is what to do and what not to do when it comes to this situation. In some circumstances, taking advantage of a refi offer may benefit you, but there are times when it is not a good idea either.

With the reduction of Federal Reserve rates for the first time in four years, US monetary policy is changing gears and returning to the zero percent level. The Fed is reversing monetary policy to try to stimulate the economy away from the possibilities of a recession. For many homeowners and homebuyers, this is good news. Lower rates mean lower monthly payments on your mortgage.

We decided to give you everything you need to know about refinancing your home and the best time to pull the trigger in a new agreement with a lender.

How changes in interest rates affect your mortgage

Knowing how the interest rate affects your mortgage requires that you understand the preferential interest rate and the federal funds rate. The federal funds rate is the rate at which banks charge each other interest for lending money overnight. The legislation requires that all banks maintain a reserve equal to a specific percentage of their total deposits, in an account held in a regional Federal Reserve bank.

The preferential interest rate defines the rate at which banks lend money to the consumer market. When you are thinking about taking a mortgage or refinancing, banks charge you the preferential interest rate.

However, banks reserve the preferential interest rate for their best clients, and you need a stellar credit score, along with a perfect payment history to receive a premium on your mortgage. In most cases, banks grant loans to consumers at one or two percentage points above the preferential rate.

It is also important to keep in mind that the preferential rate moves mainly in tune with the federal funds rate. Since the Federal Reserve is beginning to cut rates again, starting the next cycle of relaxation for the economy, the preferential rate also had a cut in early August, with the Fed announcing a cut in the Federal Funds rate of 2.5 percent to 2.25-percent.

As of August 2019, the preferential rate fell from 5.5 percent to 5.25 percent, reflecting the Federal Reserve's move toward a lower interest rate target. Many Wall Street analysts expect the Federal Reserve to continue reducing rates during the period of 2019 and 2020, before the next presidential election.

However, nobody knows how and when the Fed will induce its next rate cut, and if it will also change the preferential rate. One thing we can be sure of is that interest rates are falling, at least in the short term.

Mortgage with the best interest rate

Read: How to get the best mortgage rate: Complete guide

The current climate of the interest rate and how it affects your mortgage or refinancing agreement

With the rates down, consumers already see the dollar signs in front of their eyes. Lower rates mean that the cost of borrowing money is less and less. If you bought a house in 2016, at the beginning of the last cycle of hiking by the Federal Reserve, then you would have reached a mortgage interest rate of 3.5 percent.

Most Americans choose a fixed-rate mortgage agreement, which means they obtained a 3.5 percent interest rate on their mortgage if they applied in December 2015. As interest rates steadily increased to the level of 5.5 per One hundred in December 2018, they scored on their mortgage. A fixed rate mortgage locked them in the preferential rate of 3.5 percent, even though interest began to rise.

This moment of the market saved the owners a package in their mortgage payments by using a fixed rate mortgage. However, Americans who bought real estate in December 2015 and decided to use a variable rate mortgage were taken to the dry cleaners as interest rates increased over the next four years.

An adjustable or variable rate mortgage means that your mortgage rate tracks the preferential rate. Therefore, if you entered the mortgage with a rate of 3.5 percent, you are now paying 5.25 percent (plus points added by the lender). Therefore, your mortgage payment would increase steadily with each increase in the Federal Reserve.

Fixed rate mortgage vs variable rate

Read: Should you choose a fixed rate or variable rate mortgage?

Refinancing explained

Refinancing your mortgage means that you extend your current mortgage to the full term, allowing you to benefit from access to the accumulated capital in your home since you began making loan payments. Therefore, if you bought your home for $ 250,000 and since then you have paid $ 50,000 on the mortgage line of credit, you now have $ 50,000 in net worth of the available home through a refinancing agreement.

If you refinance your mortgage, you will withdraw the $ 50,000 and the bank or lender will extend your payment to the original date. It may be surprising that people are willing to take the risk of taking out capital from their home, but it is common in the real estate market.

There are several reasons why people would want to take out the capital from their home and return their mortgage for the total duration of the term. Maybe you want to make a down payment on an investment property to get your income? You may be thinking of remodeling some rooms in your home, or need access to capital for the education of your children. Whatever the reason, it is personal, and the banks do not ask about their reason for refinancing.

All banks and lenders are interested when you request a refi agreement, it is that you made all the payments on your previous mortgage and your credit score is healthy. Banks make money by lending money, and they are interested in making as many loans as possible to increase their balance and show a profit to their shareholders.

Market moment for refinancing offers

So when is a good time to get a refinancing agreement on your mortgage? Well, if we are following the current market conditions, then there are some answers to this question.

If you currently have a fixed-rate mortgage and obtained it in 2015 when the preferential interest rates were 3.5 percent, then it does not make much sense to refinance at this time. With interest rates currently at 5.25 percent, you'll end up paying 1.75 percent more interest on the new agreement, than what you would pay with the original mortgage.

Therefore, this strategy makes no financial sense to any homeowner, unless he is in a desperate situation, or has much available in an asset that generates more income than the additional interest he will pay for the mortgage. For example, if you are buying a rental property and have a positive cash flow from the first day that covers the additional costs related to your monthly payments.

However, if you are withdrawing capital for remodeling or other lifestyle expenses, then it is a bad financial decision, and it will end up costing you more money in paying your mortgage at the end of the month.

On the other hand, if you received a mortgage in December 2015 and made the mistake of taking an adjustable or variable rate mortgage, then it can be a good deal. A variable rate mortgage would have seen its monthly payments increase steadily over the past 4 years to a peak in December 2018 until July 2019.

Therefore, refinancing your mortgage right now with another variable rate mortgage would allow you to benefit from the cycle of interest rate reduction next year by the Federal Reserve. As the preferential rate falls along with the federal funds rate, your mortgage payments will steadily decrease over the years.

Fixed rate mortgage vs variable rate

Read: How to refinance your mortgage

Justification of refinancing costs

Refinancing your mortgage has other costs that you must consider before signing the documentation. Just like when you got your first mortgage, there are also closing costs related to your refi agreement.

Closing costs can represent between 3 and 5 percent of the total value of the agreement. Therefore, if you refinance $ 50,000 of the value of your home, you can expect to pay between $ 1,500 and $ 2,500 in closing costs, depending on the terms offered by the lender.

When it comes to closing the costs of refi deals, lenders are always more likely to charge you for the high side, since they know you need the money. While this may seem like a predatory lending strategy by banks, it is the way they choose to do business, and you have to move on.

If you are refinancing your mortgage in an attempt to get a better deal on your monthly payment, then you need to include closing costs in your monthly payment cycle. For example, if you only obtained your mortgage three years ago and wish to refinance, the $ 3,000 in closing costs would mean that the reduction in your monthly payment should be less than $ 100 for the agreement to make sense, or you are losing money on the refi .

Are you going to sell in the future?

If you are refinancing and intend to sell your home in a few years, it is not worth the additional expenses related to closing costs and refinancing charges. In this case, it is better to wait until you decide to move and then sell to get access to equity in your home.

Using this strategy saves you closing costs and allows you to earn more money on your sale as the real estate market begins to rise. Real estate appreciates over time, and it is possible that your $ 200,000 home that you bought 5 years ago is now worth around $ 220,000. When you sell your property, you can request a higher sale price and deposit the additional earnings you earned on the sale.

When interest rates begin to fall, it stimulates the economy. As a result, more people start buying real estate that they could not afford when interest rates were higher. This reduction in interest rates attracts the sellers market, as there are more buyers, allowing you to sell your home for more while increasing your chances of reaching the sales price you want.

Property prices increase depending on the location and condition of your home. For example, if you live in a school district, the price of your property is likely to increase faster than if you live in an area of ​​the state where an oil company decides to start a fracking operation on the outskirts of the city.

As with any other investment in your portfolio, you must consider the market when planning your exit strategy.


Read: How to qualify for a mortgage: Complete guide

In short: is your credit score healthy?

Another vital consideration to consider when requesting a refinance agreement is your credit score. If you bought your home five years ago, and obtained a credit score in the 700s or 800s, and since then you have had financial difficulties, then your credit score may be lower than when you first obtained your mortgage.

Your credit score determines the interest rate that the bank charges you in your mortgage facility. Most Americans with good credit scores in the 700 will receive prime plus two points. However, if you are a good customer and your credit score increases by 800 since you took your mortgage, you may qualify for a point or two less than what you are currently paying, which could save you a package in your monthly payments if you choose to refinance.

However, on the other hand, if your financial position worsened and you began to lose some payments on your credit card or other credit facilities, your credit score could be significantly lower. As a result of your lower score, your refinancing agreement could end in the first place plus three or four points, which would substantially increase your monthly mortgage payment.

Verify your free credit score with the credit bureaus before thinking about refinancing your home.


Disclaimer: The opinions expressed herein are only those of the author, not those of any bank or credit card issuer and have not been reviewed, approved or endorsed by any of these entities.

Disclaimer: The answers below are not provided or commissioned by the bank advertiser. The responses have not been reviewed, approved or supported by the bank advertiser. It is not the responsibility of the bank advertiser to ensure that all publications and / or questions are answered.

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