Loan Officer Secrets: Should I Refinance My Mortgage?

Certified Mortgage Advisor
NMLS 1701021
Published 
March 11, 2020

Should you refinance your mortgage?

Should you refinance your mortgage when rates are lower and we hear everyone talk about a refinance. It can be really hard to decide. Should you refinance now or not? And here's the big issue is everyone's telling you to refinance. Lenders, realtors, the news, but no one's giving you the opposite side.

So I want to break down and help you understand. Should you refinance? We're going to talk through the exact formula that you need to know along with some common refinance strategies.

Why from news?

So first we need to know why does everyone keeps talking about refinances all the time. When information about refinances comes from the news. We have to understand that what they want is they want viewers. They want to get people's attention. So they're going to use as luring informationas possible to get you to come to their website or watch a video, they want to get your attention. So they're usually not a great expert on it. They want to stir up emotion. So know that they want views.

What lenders and realtors want

Lenders and realtors alike, what did they want refinances, because that makes them. So we can see the people who are talking about you needing to refinance are the people who benefit from you, either having an emotional reaction to it or from refinancing.

So these people are very biased in their opinions about if you should refinance. Just know that it's a bit of a one-sided conversation. If you see everybody talking about refinancing.

Don't follow what people say

So don't go off of the emotion just because everyone in the market is saying refinancing needs to happen for you. Because if these people are saying yes and they're biased, who's the person that's saying no?

So how do we actually tell if a refinance is good?

Here is the formula that you need. You're going to take your monthly savings. Divided by the cost of the refinance to see if it's worth it. What this is going to do is show you your break-even point.

Example

So for instance, let's say right now, your monthly payment is a thousand dollars on your mortgage, and let's say you could refinance and you could drop that to let's say let's just say two or $800 per month. So you saved $200 per month. All right now, let's look at the cost of the refinance. What you need to do is talk with some lenders and see what does it cost to refinance. So you might have it on appraisal. You might have things like title fees, recording fees. You might have a prepaid interest. There might be some other fees involved in there.

How to earn from refi?

Let's say the cost of your refinance is $2,000. Now this $2,000 might be being put into your loan amount or might be paid upfront. But if we get this, we can see that we have a break, even point here of 10 months. So we know that in 10 months you broke even on your money. Then from there, you're benefiting $200 every single month. So what this helps you do is see if, is it worth it based on how long you're going to be in the house. So if I'm going to be in the house for 10 plus months, maybe a year, two years, three years down the line, then a refinance in this situation makes sense. I pass the breakeven period and now I'm profiting afterward.

When is it not worth it?

But if your breakeven period is a lot longer than you plan on staying in the house, the refinance is absolutely not worth it. I see people do this all the time, or they see a lower rate and they equate that with savings. And if you're not looking at the total picture of everything involved, you're really missing out because a lot of these big lenders, the ones that like to advertise on the Superbowl. I'm not going to mention who they are, but what they'd like to do is they like to charge points, which are prepaid interest. So you pay an upfront cost to lower your interest rate. So maybe you were at a 4% interest rate and then you paid $5,000 to lower it to a 3% interest rate then they'd take that $5,000 and they wrap it back into your loan. So all on paper is a 3% interest rate. That sounds great to me. Let's see it. But in reality, you just took five grand and financed it back into your loan. You're spending all this time, paying off debt all for it to be shoved back into a loan.

Lenders when you do this because they profit off of it, they profit off of you not knowing they profit off of you. Only looking at the interest rate. You have to look at the breakeven. You have to look at the whole picture.

So this is the simplest form to see if a refinance will work for you. It does not have to get more complicated and take your monthly savings divided by the cost of the refinance. That's how many months it takes to break even. Are you going to be on the property longer than that? Great refinance makes sense. Are you gonna be on the property shorter than that? The refinancing doesn't make sense. It is as simple as that.

Does your breakeven make sense?

So you have to know if that break-even makes sense. Something we need to watch. Is extending your loan term. So let's say you got a 30-year loan and you got that seven years ago. So you now have 23 years left to pay down your mortgage. So in 23 years, you are mortgage-free, which is awesome.

What people will do is they'll take them they're 23 years left on their mortgage, refinance it into a 30 year. So we just took our debt, our money that we spent a long time trying to pay down and pay down. And we just extended it another seven years. So you have to be careful that if you have a 23-year mortgage, don't add seven years on top of it and stretch it out to 30 years. If you have 23 years left on your mortgage refinance into a 23-year mortgage, you absolutely can do that.

It doesn't have to be a 30 or 15. You can refinance to a 30th 29 to 28, 27, 26, 25 that you can do any number that you want. You could do a five-year mortgage, six, seven, and eight and 9, 10 11. You can do whatever duration of mortgage that you want.

So this is the simplest form to see if a refinance will work for you. It does not have to get more complicated and take your monthly savings divided by the cost of the refinance. That's how many months it takes to break even. Are you going to be on the property longer than that? Great refinance makes sense. Are you gonna be on the property shorter than that? The refinancing doesn't make sense. It is as simple as that.

Watch for the points added into your loan amount

Lenders love to do this, especially these big retail lenders that function more like call centers than an effective loan company. What they like to do is they'd like to charge point, and the reason they get away with this is that people don't really look into it that much. So what points are the prepaid interest that helps you lower your interest rate? So you pay some money upfront and it lowers your interest rate.

Use your points properly

Now points are not bad in themselves if you use them properly, the problem is a lot of lenders will charge 2, 3, 4 points, which is 1% of your loan amount. And then they go and put it back into the loan amount. So it doesn't really affect you upfront because it's paid in the loan, you don't actually have to bring that money to the closing table. So people don't think about it. It doesn't have any material, weight, but that's money that you end up paying back over a period of time. And it's not a good decision. So watch out for points, add to the loan amount.

Streamline Refi

Also, something that's super beneficial. If you have a government-backed loan, so you have an FHA loan, a VA loan, or USDA you can do, what's called a streamlined refinance. So streamline refinance means that you don't need an appraisal on your property and you don't need, what's called a credit package.

What is credit package?

The lender doesn't have to verify income and your credit history and everything like that. If you refinance with a conventional loan, then you have to have an appraisal, and a lender has to look at income and assets to make sure that you're still able to qualify for the loan and the property still has a good value.

No appraisal and no income!

But with these types of government programs, there's no appraisal and no income that has to be verified, which is super awesome. These are loans that you can close super quickly. Like you could close them in a week because they don't require really a lot going on. As long as you've made your payments on time for the past 12 months, you should be good to go with that refinance.

Seasoning requirement

There is a seasoning requirement. Meaning you need to have had at least six monthly payments on time. And you also need to make sure that there have been 200 days, 210 days passed since the closing of your loan to a new refinance.

Scenario

So let's talk through some common refinance scenarios. So here are the circumstances where it might be beneficial to refinance.

1. Rates drop

When rates drop. So the market's fluctuating and changing all the time, depending on tons of different economic factors, and sometimes mortgage interest rates dropped significantly. So you might've got your interest rate at 5% and now interest rates are at three and a half percent, and it makes sense to drop your rate. Again, you're looking at your breakeven period there, but when rates drop that benefits you, and it's a good time to look at refinancing.

2. Home value increases

Also, you could refinance when your home value increases and remove mortgage insurance if you have it. So if you have mortgage insurance, you're paying mortgage insurance because you have less than 20% equity in your home.

But if your home value goes up, you might be able to have all the equity that you need to drop mortgage insurance. So that could be a good chance for you to remove the mortgage insurance and see, is it worth it to do the refi or just continue paying down on your mortgage.

3. Credit score

Also, this is the one that a lot of people don't know if your credit score increases absolutely refinance into a better loan interest rate are given based off on your credit score. So the lower your credit score, the higher your interest rate, the higher your credit score, the lower your interest rate.

So I've had clients who. We started when they got alone, initially they were at a 600 credit score. So they were in an FHA loan and their interest rate. Wasn't the greatest, because it's a 600 credit score. After six months to a year, they were able to build their credit score up to a high 600. So then we could look at refinancing into a streamlined FHA. So giving them a better rate simply because they have a higher credit score or even flipping them over into a conventional loan is going to be a lot better.

4. Refi to a shorter term

You could also refinance into a shorter term. This is going to save you so much money. So if you have a 30-year loan, you could refinance it into a 15-year loan, or maybe you have 23 years left on your mortgage, refinance that into a 15-year mortgage or a 10-year mortgage. That's going to help you save so much on interest, and those shorter loan terms actually have lower interest rates than a longer loan term.

5. Refinance to a better loan

You could also refinance into a better loan. So this is what I'd like to teach a lot with FHA. FHA loans are great, starting out, but they're not loans you want to keep for a long period of time because they have lots of mortgage insurance packed into them that usually doesn't go away.

So normally what I suggest is someone who has an FHA loan right now, maybe they were at a 600 score. If we build up that credit score over a period of a year or get it up to a seven 20 or above, then we could refinance it into a conventional loan and save a lot of money on our interest and on the mortgage insurance.

6. Cash out

You could also do a cash out. This is a little more uncommon, but maybe you want to pay off debt with your mortgage. So you have some money sitting in your home equity, maybe a hundred thousand dollars in home equity, and you want to pull that cash out and pay off some debt. That's absolutely a strategy.

Or you could use a cash out to use towards an investment property or some other investment that you want to use. So maybe you want to pull cash out of your property, do a refinance on it to then use that money on an investment.

Refinance quotes are free!

It costs you nothing to go talk with a lender and get an idea of how much you can save and how much your costs are going to be. So you can see a total picture of what your cost savings are going to be.

Is refinancing for you and your family?

There's so much noise out there with information about rates and refinancing and we should, and shouldn't do, and it's all coming from biased sources. Ultimately, you need to make the call on if a refinance is going to be a good choice for you and it does not depend on just the interest rate. It's going to come down to that breakeven formula. Does it make sense for you and your family to move forward with an interest rate based on how long you're going to be in that property? This should be a very clear idea of what you need to do to understand if refinancing is a good idea or not.

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