Tricks for Getting the Lowest Mortgage Refinance Rate
Mortgage refinancing replaces your original home loan with a new one. Common reasons for refinancing include debt consolidation, removing a name from a mortgage, or switching to a different loan program.
Regardless of the reasons behind the decision, refinancing only makes sense if you’re able to qualify for an affordable mortgage rate and save money.
Because the process creates a new loan, it also involves new mortgage terms and a new mortgage rate. Just like with your original loan application, the refinance rate you qualify for depends on numerous factors.
Here is a look at seven ways to get the lowest rate when refinancing a mortgage.
Maintain a Good Credit Score
The fact that you already have a mortgage doesn’t guarantee approval when applying for a refinance — even if you’ve never missed a payment.
Remember, refinancing replaces your existing mortgage with a new one. Therefore, you must re-apply for a home loan. You’ll undergo the underwriting process all over again, where your income, credit, debt and assets will get scrutinized. And unfortunately, if your credit score has decreased since getting the original mortgage, you could end up paying a higher interest rate, or not qualifying at all.
To maintain your credit score, it’s critical that you pay your bills on time. This doesn’t only include your mortgage, but also your utilities, credit card bills, and other installment loan payments. Keep in mind that payment history makes up about 35% of your credit score.
Lower Your Debt-to-Income Ratio
A higher debt-to-income ratio could also trigger a higher mortgage rate when refinancing. This ratio refers to the percentage of your total monthly income that goes toward debt repayment. Typically, the lower your ratio, the better your mortgage rate. Borrowers who carry a large debt load are viewed as riskier mortgage applicants.
To improve your ratio, start by paying off or paying down installment loans, such as auto loans, personal loans and student loans. If this isn’t possible, tackle your credit card debt. Ideally, credit card balances should not exceed 30% of your total credit line.
Don’t Cash Out Your Equity
If you have a hefty amount of equity, it might be tempting to apply for a cash-out refinance. This entails pulling money from your equity, which can be used for just about any purpose. Common uses for a cash-out refinance include debt consolidation, home improvements, college tuition, or capital for a start-up business. You’re allowed to borrow up to 80% to 85% of your home’s value.
Cash-out refinances are appealing, but generally – you shouldn’t tap your equity for the sake of getting money out. This type of refinance loan increases your mortgage balance. And since you must repay the amount borrowed from your equity, a cash-out increases your loan-to-value ratio and your debt-to-income ratio, which could potentially lead to a higher mortgage rate.
To avoid a higher rate, don’t take cash from your equity unless absolutely necessary. If you choose to tap your equity, only borrow what you need. In some cases, it might be better to borrow from your equity at a lower interest rate than to opt for a personal loan or credit cards with a higher APR.
Select a Shorter Mortgage Term
Choosing a shorter mortgage term is yet another way to secure a low refinance rate. Some borrowers refinance their home loans for an additional 30 years, but this isn’t the only option available.
Extending the loan another 30 years can lower payments. But if you can afford to pay more each month, compare monthly payments with a 15-year and a 20-year mortgage. The monthly payment will be higher with a shorter term, yet you’ll pay less interest over the life of the loan. You’ll also pay off the loan sooner and build equity faster.
Prepare for Closing Costs
A mortgage refinance also involves closing costs, so make sure you prepare for this expense and include it in your calculations when deciding whether or not to go through with it.
Closing costs cover lender and third-party fees, such as the loan origination, appraisal fee, attorney fees, title search and prepaids. On average, closing costs run about 2% to 5% of the mortgage balance.
To lower your out-of-pocket expense, you might be able to roll closing costs into the mortgage balance (if you have enough equity). While this approach is appealing, be mindful that it also raises your loan-to-value ratio and may result in a higher mortgage rate.
Some banks even offer lender-paid closing costs. But again, this typically results in a higher mortgage rate to compensate.
Refinance to an Adjustable-Rate Mortgage (ARM)
Switching from an adjustable-rate mortgage to a fixed-rate mortgage is a common reason to refinance. But it’s also possible to convert a fixed-rate mortgage to an adjustable-rate mortgage, especially if you’re looking to get the lowest possible mortgage rate and don’t plan to keep your house for an extended period of time.
Adjustable-rate mortgages usually start off with lower rates than fixed-rate mortgages. Keep in mind, however, the rate on an adjustable-rate mortgage will eventually adjust or reset. These loans feature a fixed-rate period — such as 3, 5 or 7 years. After this initial period, the rate resets each year based on the market.
For this reason, adjustable-rate mortgages can be unpredictable in the long run. Even so, this might be an option if you plan to sell the home before your first rate adjustment. One of our experienced loan experts can help you decide whether an adjustable-rate mortgage is right for you.
Pay Discount Points
Discount points or mortgage points are a type a prepaid interest that mortgage borrowers pay in exchange for a lower mortgage rate. This is an upfront cost paid at closing, and paying points is worth consideration if you have extra cash to put toward closing.
One discount point costs 1% of the mortgage loan. And typically, each discount point reduces your mortgage interest rate by .25%. Let’s say you’re refinancing a $200,000 mortgage and elect to pay two discount points to lower your interest rate to 3.75%. This decision could reduce your monthly mortgage payment by $60, and you’ll save nearly $20,000 in interest over the life of the loan.
The above tips offer the basics to saving money when considering refinancing your loan. Depending on your situation, there are different types of refinance loans to consider that could also help maximize your savings. It’s always best to speak with a mortgage professional to help you analyze which path is right for you.
Ethos Lending is a new type of mortgage lender. We use technology to keep our operational costs as low as possible. From closing costs to interest rates, we have made it our mission to make the process of buying a home more affordable. Get in touch with one of our mortgage specialists to learn more.