Signing documents for a 30 year mortgage seems so… definitive.
Except statistically speaking, your home is unlikely to be a “one and done thing”. Even if you keep your home for a good number of years, it doesn’t mean you have to keep the original mortgage it came with. There are lots of advantages to reassessing your mortgage debt, and figuring out how to use it to your advantage.
Life happens, goals change. Mortgage loans are simply a tool to manage the equity in a home. A low mortgage rate may help increase your equity faster, but not when it comes packed with high closing costs. And this is why I wrote this, so that hopefully you have a better understanding of what a mortgage refinance is.
Mortgage rates are finally dropping, after 2 long years of lingering in the high 6’s, 7’s and even briefly flirting with the 8% range. The expectation right now is that the Federal Reserve will cut rates this mid September, as inflation is finally showing signs of cooling down. The whole “marry the house, date the rate” thing will finally make sense, and you’re probably already hearing about it.
As a result, mortgage companies will make it their priority to pester you about a refinance, in an attempt to capture repeated business. And you should absolutely refinance – IF the math makes sense. For you, not the mortgage company’s bottom line.
Most importantly: just because you paid points, or did a rate buy-down when you purchased your home DOESN’T MEAN you should also pay points on your mortgage refinance. In most cases, it’s actually a bad idea. And I’ll explain the math behind it.
1. The basics: what is a mortgage refinance?
A mortgage refinance is a process of replacing your old mortgage loan with a brand new one, that (hopefully!) has a lower interest rate, or better loan terms. The same closing costs apply as when you purchased, minus anything related to the deed transfer, since ownership is not changing hands.
There are two types of refinances:
- “Cash-Out refinances” where you can borrow against the equity of your home
- “Rate and Term refinances” where you’re not wanting cash back, just the best terms for your new mortgage loan; Borrowers on government loans such as FHA, VA and USDA also have an option called a “streamline refinance”, which is a rate and term refinance that doesn’t look at home value, income or even the credit score.
Here I’ll be talking about the rate and term (applies to streamline refinances as well). Any cash back to you will be incidental (usually under $2,000), and closing costs can be rolled into your new loan amount – WHICH IS WHY you need to be mindful about loan balance increases.
You can always email me the details of your situation, and I’m happy to provide no hassle quotes, or help you understand a quote from a competitor. [email protected]
2. How do I know IF and WHEN I should refinance?
A good rule of thumb is that a mortgage refinance should lower your interest rate by 0.75% to 1% from your current interest rate. You should also break even on any closing costs you pay in 2 years or less, and I’ll explain how you should calculate that.
Many times, the savings or benefits are not as clear cut.
- The rate difference can be small, but maybe the refinance removes the monthly private mortgage insurance because a borrower now has enough equity in the home.
- A borrower could be struggling with a 15 year mortgage payment that his unqualified financial advisor told him to take out. Replacing the 15 year mortgage with a 30 year one can allow for a lower monthly payment that is spread out over a long period of time – this is helpful for those on a tight, fixed income.
This is where having access to a mortgage advisor you trust comes in very handy. Your instincts are great, but don’t forget to check the facts. Too many people put their loyalties in a loan officer they used when mortgage rates were low, and assume they got a good deal.
You don’t want the person that just wants to make a sale. You want a mortgage loan officer that will keep you in the loop on mortgage rate movements, and that will be straightforward about the benefits of a refinance for your particular scenario.
3. What closing costs should I expect?
I like to break down closing costs into 3 categories.
A. LENDER FEES
This includes origination charges, discount points (or just points), underwriting fee, processing fee, admin fee. This is where lenders make their money, and their profit margins are built into the interest rate, not just reflected in the charges you see. I’ll elaborate on this more, because it’s the most important part that you need to understand.
B. THIRD PARTY FEES
These are credit report fees, appraisal fees, title insurance fees, new deed recording charge, and other small miscellaneous items that may be reflected on your loan documents. These are items paid to third parties for services rendered.
You may shop some of them, such as the title insurance, but not others. For example, you don’t get to pick the appraiser, and pay more to try to influence value. Silly regulations
These are not fees to nickel-and-dime over, they’re a small piece of the pie, and prices are extremely comparable among various companies.
C. PREPAID CHARGES
These charges are your Daily Interest and Escrow Setup.
The daily interest is charged from the date your close on your loan, and until the end of the month. Be suspicious of mortgage quotes that only include 1 day of interest, unless you know with a fair bit of accuracy that you’re closing on your loan on that day. Otherwise it’s a tactic used by loan officers to make their quotes appear cheaper.
Escrow setup – on a refinance, the lender will end up collecting enough month of property taxes and home insurance to be able to pay those bills on your behalf when they come due.
in Utah, property taxes are due November 30th, so if your refinance closes in September, you won’t have a mortgage payment until November 1st. At this point, the lender will probably already have a check out to the County, so they need to collect the full 12 months of property taxes at your loan closing. A slight overage is allowed (cushion).
If your home insurance policy is due next year in February, by the time February rolls around you would have made only 4 mortgage payments. Your lender needs to collect at least 8 pre-paid months at closing.
These are regulated fees, so any variations in how they’re quoted are irrelevant – they’ll all end up the same, regardless of the lender you use. One lender quoting less than another doesn’t make your loan cheaper. Beware of low estimates on mortgage quotes, because they’re either ignorant or deceitful. The timing of your closing will determine how much is actually charged.
Depending on the loan program and personal preference, you may also have the option to waive your escrow account. This just means that you’ll pay property taxes and home insurance on your own.
4. The refinance math, and figuring out your break even point.
The easiest way to understand is with a real life example, so here are two of my client scenarios. These are not to be construed as a rate quote, and are for educational purposes only.
Client A: Conventional Mortgage Refinance
A past client reached out to me a couple of weeks ago asking about a refinance, and here is how her numbers look like. She pays her property taxes and home insurance separately from the mortgage, so her closing costs are lower than for someone who would need to escrow those fees.
She purchased her home in September 2023 with 20% down. Her interest rate right now is 6.624% and she paid very little for it. I gave her different rate options, and advised her not to spend a lot on a rate “buy down”, given the likelihood or mortgage rates dropping in the next few years.
Fast forward to August 2024, and a refinance would get her down to 5.875% for the price of $5,300 in closing costs. The monthly savings would be $218.40/mo (5,300 / 218.40 = 24.27), which makes her break even period just over 24 months.
Normally this would be a pretty good deal in terms of doing a mortgage refinance. But she’s not in a hurry, and I’m seeing mortgage rates continuing to drop. So we wait and watch, in order to maximize her savings when we decide to pull the trigger.
It’s paying off, because right now, the same 5.875% would only cost her about $1,700 in closing costs, which would make her break even period around 8 months. And with a little patience and monitoring, there’s room for it to get even better.
Client B: VA Streamline refinance (IRRRL)
My Veteran client closed on a VA Cash-Out refinance back in December, with a big name mortgage company that charged him $18,000 in discount points for a 6.625% interest rate(!!!!!)
Per mortgage “seasoning” requirements, he has to wait 210 day from the date his first mortgage payment was due on the current loan, before he can close on a new refinance loan. He started getting mailers about a VA streamline just a few months into his mortgage. His current lender also started calling him ahead of time, letting him know that rates are dropping and that he should refinance with them.
Fortunately, he reached out to me to ask about the supposedly “low VA rates” being advertised to him. I got his loan started more than a month before he was eligible to refinance, and we went through underwriting, but held off on the rate lock.
His initial loan disclosures went out with a 5.99% interest rate that didn’t cost any lender fees, but that only saved him just under $254/mo. The estimated loan costs were almost $7,500, so the break even point was 2.5 years. We watched and waited.
When his mortgage “seasoning” period was over, we had two choices. He could keep waiting, while paying the high current 6.625% interest. Or we could refinance him to a rate that not only provides savings, but that has a very short break even period.
Instead of paying for a lower rate, we went over the different options and I locked him in at 5.625% (5.632% APR) – a full percentage lower, and with about $4,800 in lender paid closing costs. He’s saving $440/mo, and he’s only rolling $2,250 worth of closing costs into his new loan amount.
The best part? His current escrow account is in the negative due to a huge home insurance premium increase – please shop your home insurance if this happens. His new loan includes the costs for a new escrow account, and has enough funds to pay his November property tax + a good amount set aside for the new home insurance premium when it comes due. There is no break even period for him, because he comes out ahead.
Had he chosen to stay in the old loan, he would not only keep paying a higher interest, but he would owe money because his escrow account had no funds to pay the property taxes in November.
Bonus: He won’t need to make his September mortgage payment, and his first mortgage payment on the new loan won’t be due until November.
It’s a safe assumption that interest rates will continue to drop into next year, so mid next year we’ll reassess if another refinance is possible, and again aim to do it in a way that doesn’t eat up his equity.
There are lots of different way to structure a refinance, depending on your goals. Maybe you want to pay off your mortgage faster, so you actually want not just a lower interest, but a lower loan term. Maybe the goal is just a lower monthly payment.
If you’d like me to run similar numbers for you (catered to your particular situation and goals), please to email me your details at [email protected]. No credit pull necessary, and no hassle. I will use the estimated credit score you give me.
5. Red flags when doing a mortgage refinance
Paying for expensive discount points
Paying expensive discount points is not REQUIRED on a mortgage, despite what some mortgage companies might have you believe. You should always be presented with a few different interest rates for comparison. A higher rate with a lower cost, a middle rate, and a low rate with reasonable discount points. Reasonable is the key. Under 1% is reasonable, but 0.5% of the loan amount is even better.
It’s important there is no set interest rate that you qualify for – there are a range of interest rates to choose from, assuming you have a loan officer that gives you that option. The cost associated with the mortgage rates you’re being offered depends on the current market conditions (The Federal Reserve policy influences this), and the mortgage company of choice – specifically how much profit they have built into the rate they’re offering you. Your choice of mortgage company will determine the cost of your interest rate, as well as impact your ability to make an educated choice.
A rate that costs you $5,000 in discount points might cost little to nothing with another mortgage company. And because of market movements, a rate that costs $10,000 today might not cost anything a few months from now. Find yourself a good mortgage loan officer that can advise you on this.
This tool from the CFPB (Consumer Financial Protection Bureau) will give you an idea of the different interest rates that are being offered in your State at any given point in time.
Focusing only on monthly payment savings
The homeowners that are most taken advantage of are the ones that only look at the monthly savings, ignoring the overall closing costs being rolled into their new loan. That right there is your home’s equity going into the pockets of a greedy mortgage company.
Shop around. I bet you can find similar savings for A LOT less.
Mailers, or other advertising that sound “too good to be true“
Advertising isn’t cheap, and you can bet you’re paying for it. Pay attention, because it is an indication of overall market trends. But shop around. Or even better, use a local mortgage broker that can shop for you.
“No cost” refinances as a marketing gimmick
There are always costs associate with a mortgage. Yes, you can get a rate that offers a good chunk of lender credit – see my VA refinance example above.
This depends on the loan program AND the mortgage company you use. Generally, what’s advertised as a “no cost” refinance just means “no out of pocket costs”. All the fees will just get rolled into your new loan amount.
Refinancing with your current loan servicer
It’s rarely a good deal. Particularly if your loan officer’s face and contact information is on your mortgage statement. This in itself comes with an advertising cost, just not the most obvious one.
Mortgage Servicing Rights (MSR) are being sold at a premium right now because loan servicers KNOW that most people won’t shop around. They’ll take the convenience of refinancing with the same mortgage company thinking it’s somehow faster, or that they’ll automatically get a good deal. Neither of those things are true.
Don’t take my word for it – I can get you a quote to compare.
Beware of mortgage loan “churning”
“Churning” is a predatory lending practice where a lender encourages a borrower to refinance their mortgage repeatedly, often with little to no benefit to the borrower. Veterans are the most at risk, and the “churning” comes from mortgage companies that a lot of times have “VA” or “Veteran” in their names. As if there was some association, or loyalty. FHA loans are second. Conventional loans tend to shop around more.
This is done by mortgage companies that charge higher interest rates than the market dictates, which is why you should always pay attention to the lender fees section on your estimate. The biggest lie the mortgage industry has gotten away with is getting borrowers (and real estate agents!) to think paying “points” is OK.
Paying points only makes sense in some situations. In most, it’s just indicative of an overpriced lender.
The combination of interest rate and lender fees you’re being offered will always depend on the mortgage company’s profit margins. That includes the advertising budget they need to account for.
6. Green flags when doing a mortgage refinance
We can’t talk about red flags without talking about the green ones too.
There are lots of good mortgage companies out there. And there are loan officers like me, that have build a business on educating their clients, not on meeting some arbitrary management sales quota.
You’ll need to dig a little deeper, and ask some extra questions, but you can usually tell when you’ve found your “mortgage person”.
- They’re responsive, and never make you feel like a bother for asking questions
- They advise, not sell, and will walk your through different scenarios and different interest rates so you can make the best choice for YOU.
- They have a good reputation. Bonus if more than one person your know has used them, and even shopped them around, only to find out that they offer the best rates on a consistent basis, without haggling or price matching.
This last one is tricky. There are loan officers that are highly respected, and well known in the industry. But they work for big brand names, and don’t offer competitive rates UNLESS shopped around. Offering both good service AND competitive mortgage rates should be part of the package, not a either/or kind of situation.
Hope this helps. If anything is unclear, if you want advice, a mortgage refinance quote, or just to say “Hi, I love your blog posts”, I’m here for it.
[email protected] or you can text me at 801-473-3154.
Love your house, but not your mortgage loan? Let’s see if we can fix that.