Homeowners who refinanced a $200,000 mortgage in the first quarter of 2015 have already saved thousands of dollars, according to Freddie Mac. Unfortunately, many other homeowners have not taken advantage of the recent low interest rates -- and their inaction has come at a big cost: A study published in Journal of Financial Economics revealed that homeowners missed out on $5.4 billion in savings because 20% of homeowners who would have benefited from refinancing did not pursue the option .
Researchers suggest that a lack of understanding of the benefits and costs of a refinance explain why one in five homeowners pays more for their mortgage than they should. Given the wide variety of lenders, loan options, and refinance terms, it's easy to see why people get confused.
But ignorance doesn't have to cost you thousands. If refinancing makes financial sense for you, take these steps to help you get a great deal to lower both your monthly bills and your total mortgage costs.
Consider a shorter-term loan
The shorter your loan term, the lower the risk and the costs for lenders, and thus the lower your mortgage rate will be. Refinancing from a 30-year mortgage to a 15-year mortgage, for example, can make a dramatic difference.
As of March 9, 2017, the national refinance rates according to Zillow.com were 4.03% for a 30-year fixed-rate refinance and 3.21% for a 15-year fixed-rate refinance. How much of an impact does that make? Consider this chart showing the total costs of a 15-year and 30-year loan at Zillow's listed rates:
|Mortgage Balance||15-Year Loan||30-Year Loan|
Monthly payments are higher with a 15-year loan, since you're repaying your balance faster. On a $200,000 loan, your monthly payment for a 30-year mortgage at 4.03% is $958. The same loan over 15 years at the lower interest rate would have a monthly payment of $1,401. If you can afford the extra monthly expense, you'll save substantially over the long-term.
Improve your credit score
Improving your credit score is one of the most significant ways to get a better refinance rate and bring down both your monthly payments and your total mortgage costs.
Data from myFICO.com, with interest rates current as of March 8, shows how big of an impact your credit score makes when you refinance a $200,000 mortgage into a new 30-year fixed rate mortgage.
|FICO Score||APR||Monthly Payment|
If your credit score falls below 620, refinancing will typically not be possible at all.
To improve your score, make all payments on time. Avoid applying for new credit when you're planning a refinance, as lender inquiries cause your score to drop. Pay down credit cards, as a low credit utilization rate (i.e., your balance divided by your available credit) shows responsibility. However, don't close your credit cards, because that will raise your utilization rate and lower the average age of your credit accounts, which is a major factor in your credit score.
Another tip: Send a letter to your creditor asking for a "good-will adjustment" if there's a black eye on your credit report. If you've generally been a good customer but you had an oops -- say, you paid late or missed a payment because of temporary hardship -- then your creditor may remove this slip-up from your record.
If your score is low, you have a choice to make: wait to refinance until your credit improves and risk watching interest rates rise in the meantime, or move forward at a higher rate. Knowing how long it will take to improve your score can impact your choice. VantageScore has estimated the maximum impact of negatives and the length of time it may take for your score to recover. The impact of closing an account fades in three months, but it takes 18 months for your score to recover from the drop caused by a missed payment. If you're only a few months away from a score increase, holding off may make sense.
Correct errors in your credit report
One out of every five Americans has at least one error on their credit reports, according to a 2013 study by the Federal Trade Commission, and 5% of consumers have an error that could result in higher payments.
To identify errors, review your full credit report from AnnualCreditReport. If you identify inaccurate information, contact the credit bureau. You can dispute inaccurate information online at Experian, Equifax, and TransUnion.
Creditors generally must investigate disputes within 30 days, so it could take more than a month for your score to update. If you know you're refinancing, obtain a copy of your report months before shopping for mortgage rates to correct errors early.
Lower debt balances
When evaluating risk, lenders consider not only your credit score, but also the amount of your income that you use to pay expenses. There are two different numbers that matter:
- Your housing expense-to-income ratio, which compares your income to your total housing expenses, including your mortgage payment, property taxes, home insurance, and any association dues.
- Your total debt-to-income (DTI) ratio, which compares your income to all of your monthly debt obligations, including mortgage loans, credit card debt, and student loans.
Most lenders want your DTI to be 36% or less and your housing expense ratio to be 28% or less. If your ratios are too high, you may be unable to refinance. Lower ratios can lead to better loan terms, including lower interest rates.
Paying down debt lowers your DTI, which also raises your credit score. Avoid taking cash out in your refi to keep your housing expense ratio low.
Shop around among different lenders
Generally, you do not have to refinance with the lender who currently holds your mortgage note. A streamlined refinance with a current mortgage-provider sometimes offers perks, including reduced paperwork and better terms. But this is not always the case.
Compare loan terms among different banks and credit unions to determine which lender offers the best overall deal. Consider:
- Interest rate
- Annual percentage rate (a yearly rate calculated by considering interest costs and fees over the life of the loan)
- Discount points (money paid up front to lower the interest rate)
- Pre-payment penalties
- Other costs including loan origination fees, appraisal costs, and bank fees
- Lock-in terms (how long is your rate guaranteed, and under what terms)
Each lender should provide a good-faith estimate of total costs. Ensure the loans you're comparing offer similar terms so you can select the best overall deal.
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