Mortgage Refinancing in the Age of the Pandemic

Mortgage rates are at a record lows fluctuating right around 3%, down from nearly 7% in 2008 – so is it time to refinance your mortgage? With all the uncertainty the pandemic has brought refinancing your mortgage may be a significant financial lever for a lower monthly payment or to take out some equity from your home for a much needed cash infusion. As you start thinking about the possibilities here are a few things you should know:

Know your numbers: What is your current interest rate?

The 30-year interest rate has fluctuated quite a bit over the last ten years. Most lenders advise clients only to consider refinancing if the new interest rate is at least 1% below your current rate. As low as a 0.5% difference may be of value given other factors. Maybe the decision for refinancing is to move from an ARM (adjustable-rate mortgage) to a fixed-rate or to dump the PMI (private mortgage insurance) if you have an FMA or other loan type that doesn’t automatically remove the PMI once the amount owed on the loan is less than 80% of its value. Start by getting your free mortgage refinance rate here.

How much equity do you have in your home?

The more equity a homeowner has, the easier it will be to refinance. If you are refinancing, in part, to remove your PMI, you must have at least 20% equality in your home. Those looking for a cash infusion or consolidating debt should consider the difference between secured and unsecured debt. Defaulting on a credit card (unsecured) damages your credit; defaulting on a home loan (secured) means foreclosure.

Think long and hard about how the mortgage will be paid with your other expenses, which are likely to rise over time. Physiologists have studied short term vs. long term rewards and found people will choose the short-term reward over a long term goal. People also tend to be overly optimistic about their future earnings, so take a moment and give your finances, your future, and your goals a hard, clear-eyed look.

What is your credit score?

Those amazing deals that pop up online and in emails, that advertise interest rates lower than the weekly averages have two components – your credit score and points.

Credit scores of 720 or higher are often considered the sweet spot – lots of rates published on the web use that as their baseline estimate. This is deceptive.

The average credit score in the U.S. is 680 based on the VantageScore model and 703 based on the FICO score model.

WalletHub

In addition, scores vary by region and age. In the South, the average credit score is 667. Older individuals average higher credit scores than younger with those in their 20’s averaging 662 and those in their 50s averaging 702.

Lower credit score equals a higher interest rate

An example: Let’s look at a home value at 300k, with 20% equity, asking for a loan amount of 240k on a thirty-year fixed mortgage – and location matters, so a suburb of Pittsburgh, PA.

Credit Score: – Interest rate available

740 – 3.02% w/o points 2.61% w/ 1.025 in points
720 – 239 3.14% w/o points 2.63% w/ 1.275 in points
700 – 719 – 3.08% w/ .561 in points 2.67% w/ 1.775 in points
680 – 699 – No lenders!

Move location to a suburb of Portland, OR to see if there was a difference in lenders:

680 – 699 3.49% w/o points
660 – 679 No lenders!

As the credit score goes down, the base lending rate goes up. So, know your score! Sign up for one of the aggregate reporting sites, if you haven’t already. There are three major credit reporting agencies – Experian, Transunion and Equifax – and each has a slightly different algorithm they use to generate credit scores. See more details in this article.

Or you can go to companies that pull data from different credit reporting agencies and provide one place to keep track of credit scores, insight into how to improve, change alerts, and data about why scores change. This includes companies like Credit Karma, Credit Sesame and NerdWallet. A free annual credit report (not a score) can also be requested here.

Knowing your score will help you weed through the data to find out what is a good deal and get a great mortgage refinance rate.

So, what are points? Points are a way to decrease your mortgage rate, and your monthly mortgage bill, by buying down your mortgage interest rate. Sometimes it is worth it – sometimes it isn’t.

A point is a discount of 0.25% of the mortgage rate. For every point, the homeowner will usually pay 1% of their mortgage cost.

Are you willing to pay for points?

Continuing our home refinancing example from above it would cost

$2,460 for 1.025 points
$3,069 for 1.275 points
$4,260 for 1.775 points

Paying down points can get expensive fast. The question becomes how able the homeowner is to fund the buy down to decrease the mortgage’s monthly rate.

How much time is left on the mortgage?

A ten-year-old mortgage only has 20 years left on its life. Is there enough value in the monthly decrease to add ten more years?

There are refinancing options for 10, 15, and 20-years. It’s possible refinancing at a lower rate would decrease the amount of interest paid on the loan. With the average 30-year fixed mortgage, homeowners will pay 2/3s of that in interest – making a $300,000 home cost $515,607 by the time it is paid off.

If the interest rate drop is significant enough, the equity in the house enough, and the monthly mortgage payment is equal or just a little bit more – this may be a great opportunity to refinance and pay less in the long run.

What is your Debt-to-Income Ratio?

Lenders look at all aspects of your finances, and a significant metric is your debt vs. income. Lenders aren’t looking at total debt but how the monthly debt payments impact your ability to pay your mortgage. 

Conventional lenders prefer a debt-to-income ratio of less than 36% inclusive of the homeowner’s mortgage. Mortgage debt alone should not exceed 28% of income.

Taking the average household income of $60,000 a year – let’s divide that by 12 give a monthly household income of $5,000. Looking at the Lender’s preferred Debt-to-Income ratio:

Mortgage- $1,400 or less

Additional debt (school, car, credit cards) – $400 or less

Total monthly payments on all debt: $1,800 or less

If your income has decreased, or debt increased since the original mortgage, refinancing with a conventional lender may not be possible.

Be realistic

What lenders are looking for, may not be with fits with your lifestyle. The debt-to-income ratio, used by lenders, is based on Gross Income, but what people live on is Net Income.

Net the total amount in your paycheck after federal, state, and local taxes, payroll taxes (Social Security, Medicare, and Medicaid), 401k, health insurance and anything else deducted by your employer. 

So, back to our average household income of $60,000 a year with a Gross monthly income of $5,000. 

Figuring your Net Income: First, the average tax burden on 60k is 22%, so that comes off the top bringing the Net Income or take-home, down to $4,250 a month. 

Then your employer will include and pre or post-tax deductions, including but not limited to health insurance contribution, 401k, disability, and others. A general estimation of this is difficult given the tremendous number of variables, however take-home incomes of $3,500, after deductions, are not unusual. 

Debt-to-income will define what a lender will do for you, but you need to set your goals and be realistic about your lifestyle costs.

Can you do it?

Do you have the credit score, debt-to-income ratio, equity in the home, and an initial interest rate high enough to make the process worthwhile?

Is it worth it?

Will refinancing provide enough benefits to offset the time and upfront costs associated with the process? If you pay 4k in fees and save $200 a month – it will take 20 months before the upfront costs are paid off.

In the end, it pays to do the research! But first start with a free estimate of your mortgage refinance rate to see how much you can save.

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