There's a reason many homeowners rushed to refinance their mortgages in 2020 -- borrowers had an opportunity to capitalize on historically low rates. But what if you missed the boat on refinancing this year? Should you gear up to make that move in 2021? We spoke to PK Parekh, senior vice president of Discover Home Loans, to get some insight on why it still pays to refinance.
First, let's talk about why and when refinancing makes sense. When you refinance, you swap an existing mortgage for a new one at a lower interest rate. A refinance could help you lower your monthly payments and save on mortgage interest throughout your repayment window.
Refinancing generally makes sense if you think you'll stay in your home long enough to recoup your closing costs. Closing costs are the various fees you'll be charged to finalize your mortgage. They generally amount to 2% to 5% of your loan amount, so can be substantial. However, if your refinance costs you $4,000 and you cut your monthly mortgage payment by $200, you'll break even in 20 months. From there, you'll enjoy savings as long as you continue to live in your home and pay your mortgage.
For more on why you should refinance our mortgage, check out our guide.
Refinance rates are incredibly low right now and there's a chance they'll stay that way in the coming year. As such, refinancing could really pay off. However, there is one thing you should know about. Effective Dec. 1, 2020, a 0.5% "adverse market" fee will apply to mortgage refinances worth $125,000 or more. Many lenders will, not surprisingly, seek to pass that expense onto their borrowers. But Parekh believes that in spite of the fee, refinancing is still worth looking into.
"Mortgage rates are at historic lows, so in a lot of cases it still makes sense even with the adverse market fee," he says. "Keep in mind, some kinds of mortgages are subject to the adverse market fee and some are not."
Parekh points out that not all lenders sell mortgages to Fannie Mae and Freddie Mac, the government-sponsored entities that buy mortgages and established the fee in the first place. As such, some loans won't be subject to that 0.5% charge. Such is the case with Discover Home Loans.
"Homeowners interested in refinancing should shop around and ask lenders up-front if they are offering a mortgage that is or isn't subject to the adverse market fee and, if it is, how the fee will be reflected in the interest rate or closing costs for the new mortgage," he continued. "Some lenders may roll it into the rate they offer, while others may charge it as part of the fees at closing."
For refinancing to really make sense next year, you'll want to set yourself up to score the lowest mortgage rate possible. Parekh has some advice on how to do that.
"The best thing homeowners can do is do a little research," he explains. "Compare the rates and also consider the full cost of borrowing. Not every mortgage is the same, and rates and closing costs, and other fees can vary a lot by lender. That includes any costs for appraisals, title services, recording, taxes, and other items."
Of course, the pandemic means it will be especially crucial to vet lenders in 2021. The simple act of sitting down to close on a refinance poses a potential risk. Parekh advises borrowers to explore their options for contactless or limited-contact closings in the course of their research.
In addition to that research, you're more likely to get a great rate on a mortgage if you go in with a solid credit score -- ideally, in the mid-700s or above. Keeping your existing debt to a minimum will also help you qualify for a great rate, as will a steady source of income.
We don't know how mortgage rates will trend in 2021. But we do know that right now, they're sitting at historic lows. If you get moving on your refinance application early in the new year, you may be able to snag a rate that makes your monthly payments far more affordable.
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