Largely credited with keeping the housing market brisk during the coronavirus pandemic, mortgage rates have recently dipped to historic lows. While Freddie Mac’s weekly average pegged the 30-year fixed rate at 3.13% yesterday, some home buyers are already seeing interest rates below 3%, a steep reduction from only two years ago when rates hovered close to 5%.
It is not only home shoppers who are taking advantage of the cheap cost of borrowed money. Homeowners are, too, through mortgage refinances. The latest reading of the Mortgage Bankers Association’s refinance index is 76% higher than a year ago. The trade group expects refinance originations to grow to $1.35 billion this year, reaching their highest level since 2012.
This propitious financing environment is precipitated by the Federal Reserve’s commitment to keep interest rates low (near 0%) and continue purchasing mortgage-backed securities in order to help the economy scale back the sharp Covid-19 downturn.
Before homeowners rush to refinance their mortgages, though, there are some basic questions to think about. Jerry Anderson, vice president of residential lending at Alliant Credit Union, helps shed light on some of the fundamentals.
When should a mortgage holder refinance?
“Your specific situation could be very different from mine but everybody really has the opportunity right now,” Anderson says.
In general, homeowners should consider refinancing their mortgage when doing so would lower their monthly outlays, shorten the life of their loan or allow them to “pull out” cash – or equity – from their abodes.
While interest rates are at historic lows, the savings (not the rate) a refinance offers should drive homeowners’ decision, Anderson says.
“Nobody ever goes, ‘Oh, I wish I had a 3% rate or I wish I had a 4% rate,’” Anderson says. “They go, ‘Oh, I wish my payment was lower.’ So it really comes down to factoring in how much lower my payments can go.”
For example, slashing the interest rate from 3.8% to 3.5% on a $400,000, 30-year fixed-rate mortgage, initiated 5 years ago, could result in $250 saved every month, if the refinanced loan also lasts three decades. Yet, keeping the term the same, effectively restarting the clock, would mean more paid in interest overall.
“The flip side of that is going to be someone who is comfortable with their payment and who wants to accelerate paying off their loan, in which case they can shorten their term,” Anderson says.
But sometimes this might also produce higher monthly payments.
Tapping the savings homeowners have accumulated in their residences through cash-out refinances is another reason to restructure their home loans. In this circumstance, though, homeowners usually have other options, too, such as a home equity loan. Unlike a cash-out refinance, which extends the life of the first lien, the latter is a second loan made against the equity in a home.
The good news is that home equity has grown even through the current economic downturn as home prices have remained stable. The bad news is that some lenders have tightened their requirements on cash-out refinances, which typically cost more.
What documentation do lenders need from homeowners to do a refinance in light of the pandemic?
The typical documents lenders ask for – think employment records and third-party property appraisals – haven’t changed because of the pandemic. The novelty, though, is lenders’ closer scrutiny of income, as millions of Americans have lost their jobs either permanently or temporarily due to the coronavirus – and, four months in, companies continue to announce layoffs.
“Instead of verifying employment within 30 days to 10 days [before closing], some lenders are requiring verification of employment even up to three days prior to the closing,” Anderson said. “If there is any type of reduced hours or a layoff or a furlough, the lender obviously wants to catch that just to ensure that the borrower can continue to make payments.”
What are the fees and costs of a mortgage refinance?
Refinancing a mortgage could be an expensive endeavor, which may rake up thousands of dollars in fees and costs.
“There's always a trade-off between interest rate and fees,” says Anderson. “If you want the absolute lowest interest rate, then you're going to have to pay a fee.”
While third-party expenses such as appraisals and lender’s title insurance need to be paid out of pocket, loan origination and closing fees can often be rolled into the loan.
Folded into the loan or not, fees might change homeowners’ calculus on a refinance loan, especially when they take several years to recover through decreased monthly payments.
“If it takes me a year to recoup my fees, it is pretty easy to refinance,” Anderson says. “If it takes two, three years to capture your fees, then you've got to think about it and say, ‘Well, am I really better off paying these fees two to three years before I break even?’ And the answer very well might be yes.”
How does mortgage forbearance impact refinances?
In order to refinance a home loan, borrowers need to be current on their payments. This means they must make three consecutive payments after exiting forbearance.
“Potentially, a person who took a six-month forbearance three months ago, it could be six months from now before they're even eligible to refinance,” Anderson says.
He adds that borrowers who leave forbearance early, covering upfront any skipped outlays, might qualify for refinance quicker, depending on their lenders’ provisions.
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