Don’t Refinance Until You Read
These 6 Simple Rules
We all want to be smart about refinancing our mortgage. Done right, it can save thousands of dollars in interest and lower your monthly mortgage payment. Done wrong, it can be a money loser if you have to sell. So don’t just pay attention to interest rates—follow these six refinancing rules to know when and how you should refinance.
There used to be a rule of thumb that said to refinance only when you could shave at least 1% off your interest rate. But with today’s ultralow interest rates, that rule has gone the way of the VCR. Today, the ability to shave your interest by half a percentage point is a viable option.
But don’t go chasing interest rates with refinancing—you shouldn’t refinance more than two or three times during your loan.
You can refinance your Federal Housing Administration loan into a different mortgage to shed any FHA premiums.
Many FHA loans require mortgage insurance for the life of the loan. For example, if you have a 30-year FHA loan and put less than 10% down—a common move for FHA borrowers—you would be expected to pay premiums for the life of the loan. Other nongovernment loans (except Veterans Affairs loans) may require private mortgage insurance, which can be canceled after you reach 20% equity in your home.
And although the FHA recently dropped rates, paying a monthly premium when you have decent equity built up isn’t desirable. Plus, the FHA could always increase its rates in the future. Just be sure to compare your new PMI rates with your old premiums to see how much you’ll save.
After five years of homeownership, refinancing one 30-year mortgage into another 30-year mortgage isn’t always the right move, even if you save money on a rate reduction. You can save money on a monthly basis, but you’re also resetting the mortgage clock and adding another five years to the life of your loan.
To reduce the pain, try to pay a little extra toward your new mortgage each month. Any extra money you pay will go toward your principal, which will build you equity faster and reduce the total amount paid on interest.
You should also consider shorter loan lengths if your financial situation has improved.
For example, say you have had a 30-year FRM of $350,000 at a 4.7% interest rate for five years. After five years of on-time payments, you owe $320,000 on your mortgage.
If you refinance that $320,000 into a 15-year FRM with an interest rate of 3%, you’ll pay $602 more per month—but after 15 years, you’ll own your home outright. You’ll also have saved $218,419 in interest payments.
It’s not the right situation for everyone, but crunch the numbers to see how much a shorter loan could save you in the long run.
Because refinancing comes with closing costs, you can determine when you’ll be able to recoup those costs with your monthly savings.
For example, say you spent $5,000 in closing costs to refinance and your new mortgage saves you $250 a month. It’ll take you 20 months before you recoup your closing costs and actually begin saving money. If you can recoup those costs in less than five years—preferably within three years—of a refinance, you’ve made a good deal.
This is especially important if you are considering selling. In the above example, if you sell within that 20-month time frame, it’s a money-losing proposition.
Don’t just go to your old lender for a refinancing package. It pays to shop around—don’t assume because rates are at all-time lows that they’ll be the same every place you look. Rates can differ substantially among lenders when there are lots of people shopping for a new mortgage.
Want to know a (mostly) secret way to lower your home insurance premiums? One that could also reduce your mortgage, and even affect how much you pay for your car and car insurance?
It’s really not a secret, nor is it magic. It’s something anyone can do: maintaining a good credit score.
You likely know and understand how your credit history figures into the decision when you apply for a credit card or try to open an account at a clothing or furniture store. The credit card company or store wants to make sure you have a history of paying your bills on time.
And you probably know car dealers run your credit when you want to buy a car. What you might not know is that your credit history plays into the interest rate you’re offered — which affects the total payback on your loan.
The same applies to your home loan. Your credit will affect the interest rate for your mortgage, and the difference in that interest rate over a 30-year loan period can add up to tens of thousands of dollars.
Insurance companies have a different reason for examining your credit report. They don’t look at it to calculate your risk of paying your premium — you always pay in advance of coverage anyway. What they do use your score for is to determine your risk of filing a claim.
Yes, that’s right. Insurance companies have, since the early 1990s, used your credit reports to predict the possibility that homeowners will have a fire, suffer a break-in, have a tree fall on the roof, or be the victim of some other covered peril. They do the same for auto insurance policyholders.
Only three states — California, Hawaii and Massachusetts — ban the use of credit scores in setting insurance premiums.
Insurance companies started using credit histories to determine premiums because studies have shown that those with higher credit scores file fewer claims. Insurance companies believed that using the credit-based scores would help get more accurate and fair rates for policyholders — in fact, the industry says it actually results in lower premiums for most policyholders.
However, many consumer groups criticize the practice because they believe it penalizes those that have previously run into medical emergencies and financial difficulties, and unfavorably affects low-income and minority customers.
How much does a credit score affect premiums? A study by the Consumer Federation of America found that one large provider charged poor-credit customers about 127 percent more than policyholders with the best credit scores.
There’s no quick fix for a bad credit score. It takes time and discipline to pay bills down while avoiding new debt. But given the potential for saving on your mortgage and your insurance premiums — as well as on car and other large purchases — it’s worth the effort.
One step you can take immediately is to check your credit report and correct errors that could reflect badly on your score.
Take charge of your finances by building a good credit history and improving your credit score. You can save a bundle — now and in the future.
Mortgage rates fell this week, with lenders offering a 30-year fixed loan at an average of 3.69%, down from 3.78% a week ago, Freddie Mac said.
The mortgage giant’s weekly survey, released Thursday, showed the average rate on a 15-year fixed mortgage fell to 2.97% from 3.06% last week.
The initial rate on loans fixed for five years before adjusting dropped to 2.92%.
Low rates could spur more home sales during the spring buying season. It’s too early to tell if cheaper borrowing costs and recent robust job growth will ignite a housing market that has slowed in the last year.
Southern California home sales dropped in February. And the volume of previously owned homes sold nationally remained sluggish.
Still, Freddie Mac economist Len Kiefer said lower rates are “a welcome sign” for prospective home buyers. A year ago the average rate on a 30-year fixed loan was 4.40%.
Freddie Mac’s survey asks lenders each week about the terms they offer low-risk borrowers on loans up to $417,000.
Actual rates are influenced by many factors, including a borrower’s debt load and credit history.
“Pay yourself first,” says Kathleen Hastings, portfolio manager with FBB Capital Partners, based in Bethesda, Maryland. “And it’s important to have treats.”
Translation: Financial advisors aren’t misers. If you channel most of your windfall to existing or new investments, it’s more than OK to skim off a bit for a new tech toy or a weekend getaway. Just decide in advance how much you’ll divert to the splurge and stick to the plan.
Of course, as advisors point out, you should use your refund first to pay off debt or build your emergency fund before locking it into investments. It’s counterproductive, they say, to try to grow investments when you are losing twice as much in credit card or student loan interest. These three advisor-approved investments will likely make the most of a $3,000 to $4,000 refund.
Apply it to a down payment or home equity. First, sort through your priorities. If you have short-term goals for building your portfolio, it may be smart to use your refund to stoke that goal, says Erik Dullenkopf, a financial advisor with MetLife Premier Client Group in Ventura, California.
“If you are saving a down payment for a first home, second home or a retirement home, consider putting your refund toward that,” Dullenkopf says. Don’t worry about capturing much gain; just park the money in a safe short-term fund or even in a savings account, he recommends. “The risk [of investing in] bonds or stocks for a couple of years is not worth it,” he says.
If you already own a home, consider accelerating the payoff of your mortgage by using the refund to pay down principal, Hastings says. Early payments “shave years off of the mortgage because the interest is calculated daily,” she says. You can estimate the direct impact of a couple of early payments by using a mortgage payoff calculator.
Pay it forward. If you are thinking about the long term, one fast way to amplify the impact of the return is by adding it to your workplace 401(k) to meet the maximum match from your employer, says Suzanne Matthews, director of the Center for Financial and Economic Education at Westchester Community College in Valhalla, New York.
If you are middle-aged and building your retirement account, consider opening a Roth individual retirement account with the refund to get a toehold with a post-retirement, tax-sheltered stream of income, Matthews recommends. The same holds if you have been pondering an educational savings plan, such as a 529 account. Financial advisors agree that simply having enough money to open an account feels like a barrier to many people. Using the refund to open the account makes it easier to get in the habit of steadily building it, even with small amounts.
Diversify. “This is a good opportunity to look under the hood of your 401(k) and see if you want to add funds to some current investments,” Matthews says. If you have an itch to try something different with your portfolio, consider buying a specialty bond or stock fund with the refund. “Use exchange-traded funds to round out a sector you have an interest in,” Matthews suggests. If you are close to retirement and are cutting back on equities, apply the same theory to bond funds, she suggests.
But there is one thing advisors say you shouldn’t do with that check: Take a flyer on a single stock.
“Resist the urge,” Dullenkopf says. Sinking the money into shares of a single company doesn’t really complement your portfolio if you are already well diversified. If you have an itch to invest in something out of the mainstream, explore specialty index funds and ETFs instead. You’ll get a little of the excitement of a specialized investment, Dullenkopf says, with little of the risk.
Matthews adds: “I don’t recommend that people buy individual stocks unless they really have time to research it. It’s too much risk, putting too much money in a single sector. Get the diversification by buying a sector ETF.”
The biggest barrier for many would-be homeowners is the pile of cash that’s needed before a bank will even discuss a mortgage. The Federal Housing Administration, in an effort to boost the housing market, recently lowered down-payment requirements to 3.5% of the purchase price, but by the time would-be buyers consider closing costs, they still need roughly 7%. Even in an FHA loan, families buying a typical $300,000 home need a $21,000 bank account — no small feat when median American household income is about $54,000.Building up a $6,000 mortgage war chest is a lot easier, and puts homeownership within reach of far more low and moderate-income families. That’s the goal of Homewise, an organization that arranges low-cost financing that covers 98% of the purchase price for buyers. But an easy-to-reach down payment requirement is only one benefit of Homewise, which serves New Mexico residents. Borrowers also get to skip high-cost mortgage insurance, high upfront FHA fees, or expensive second loans often required of less-than-20%-down purchases. And, if they use Homewise real estate agents, they pay a lot less in closing costs, too.
To qualify, buyers must complete a program designed to teach them the ins and outs of homeownership, including what it takes to ensure mortgage payments arrive on time. And their household income can’t exceed about $82,000.
Combine low down payments, cheaper monthly costs, and educated borrowers and what do you get? Default rates that are stunningly low compared to traditional low-down-payment FHA loans. The Urban Institute recently released a study of Homewise, and found that the organization’s 90-day delinquency (“serious delinquency”) rate was 1.1% for loans serviced between 2009 and 2013. This rate is well below the 7.3% serious delinquency rate of FHA-backed loans at the end of 2013.
“This is a neat model that appears to work,” said Brett Theodos, who wrote the report. He’s a senior research associate in the Metropolitan Housing and Communities Policy Center at the Urban Institute. “And they’ve captured something like 25% of the (low-cost loan) market share in that area.”
Thanks in part to the low default rate, Homewise is profitable, making it potentially repeatable around the country, Theodos said.
So far, Homewise is still relatively small: it’s financed about 3,000 home purchases, while working with 11,908 clients, said spokeswoman Rachel Silva.
Plenty of nonprofits have offered housing counseling before; separately, others have offered low-cost loans. Part of the Homewise charm is it works with buyers through the entire process — from helping them open special down-payment savings accounts, to signing closing papers. Most nonprofits’ housing counselors prepare would-be homebuyers and then hand them off to traditional banks, where things might not go smoothly. And those nonprofits have to struggle for funding.
In the Homewise model, modest profits from closing loans are used to fund the counseling activity. Homewise loans are ultimately sold to Fannie Mae like traditional mortgages, allowing the firm to originate new loans.
“This allows them to capture the value. What would be exciting is if this model caught hold with other types of orgs doing this kind of work,” Theodos said. “In an era where foreclosure mitigation counseling is going away, HUD counseling is being pared back, there needs to be some model that’s sustainable for helping people get into homes.”
How Homebuyers Save
It shouldn’t be very surprising that Homewise clients pile up success stories. Just avoiding mortgage insurance saves average clients about $130 monthly, the Urban Institute says. And there’s another serious benefit — Homewise real estate agents are paid by the hour, not a commission based on percentage of the sale price. That saves clients money and helps make sure buyers get into homes they can afford.
“Homewise’s model suggests that with a carefully structured, vertically integrated system, homeownership can be encouraged in a way that better aligns risks and incentives for the counselor, the borrower, and the lender,” the report says.
Homewise is not a nonprofit. It’s a “Community Development Financial Institute,” a set of small financial institutions authorized by the Treasury Department that have a stated goal of being profit-making, but not profit maximizing. They offer personal and business loans to consumers who might not otherwise be served by traditional banking.
One barrier to replication of the Homewise model — for-profit banks might balk at the idea, although Theodos is not too worried about that. Many banks aren’t crazy about doing these low-cost loans, anyway. That risk would only arise if Homewise started reaching into higher-income client pools.
Instead, Theodos thinks the real challenge is finding institutions that have both the heart to do counseling and the head to do loan underwriting.
“We don’t expect it will replace FHA loans, and don’t think that’s the goal or expectation,” he said. “(But) the ability of the program to make revenues … and through those efforts to fund counseling and coaching, that’s really interesting.”
Can You Get a Low-Down Payment Mortgage?
What if you want a low down-payment loan? Unless you live near Santa Fe, or Albuquerque, where Homewise is now expanding operations, you can’t work with Homewise. FHA loans are the closest alternative, with the aforementioned caveat of higher down payments, a big upfront insurance fee, and ongoing insurance premiums.
Military veterans have the option of getting a zero-down Veterans Administration loan, but they pay a “funding fee” of roughly 2% to 3%. Some credit unions offer similar zero-down, funding-fee programs, such as Navy Federal Credit Union.
Finally, many consumers can qualify for more traditional 5% down payment loans if they agree to pay private mortgage insurance. That can easily add a couple of hundred dollars per month to a mortgage payment, but PMI can be canceled once a homeowners’ equity reaches 20% through a combination of loan payments and increased housing value.
Applying for a mortgage soon? Consider this: Improving your credit health could limit how much you’ll need to pay in interest and potentially save you thousands of dollars.
According to Zillow, the median home value in the United States is $178,500. Let’s pretend that two people each want a $178,500 30-year fixed mortgage and have the same amount saved up for a down payment. However, one has an excellent credit score of 760 while the other has a poor score of 620.
How much more do you think the person with the poor credit score will have to pay?
In most cases, poor credit could cost that consumer tens of thousands of dollars. Even the seemingly minuscule difference between a 3.5 percent interest rate and a 5 percent interest rate could tack on an extra $59,000 or more over the life of the mortgage, according to FICO’s loan savings calculator. (Keep in mind, interest rates and savings can vary and are ultimately up to the lender.)
It’s clear that your credit is important. Let’s discuss a few ways to prepare your credit in the months or years leading up to your mortgage application:
1. Monitor your credit score.
Your credit score will likely be one of the most important aspects of the approval process. Don’t go into the mortgage process blind. Instead, check your score ahead of time so you can estimate what kind of rates you may get and whether your credit is good enough to get you approved. Then, identify areas of your credit history that need work, make steps to improve and continually monitor your progress.
2. Pull your credit reports and dispute errors.
A 2013 Federal Trade Commission study found that 1 in 4 consumers identified errors on their credit reports that might affect their credit scores. The same study found that 5 percent had errors on one of their reports that could lead to them paying more for products such as auto loans and mortgages.
Don’t let errors on your credit reports cause you to pay more than you should. Before looking for a mortgage, be sure to pull all three of your credit reports and dispute any errors that could affect your score, such an incorrect account or the wrong credit limit. The dispute process may not be instantaneous, but the time and effort you put into ensuring your reports accurately represent your credit history will be worth it if it saves you money on interest.
3. Pay off outstanding delinquent accounts.
Like other lenders, mortgage underwriters want to ensure you’re a reliable borrower who will make payments on time, so having outstanding delinquent accounts on your credit report can drastically hurt your chance of being approved. Before you apply, consider paying off any delinquencies. Also try to lessen the impact late payments may have on your score by burying them with months or years of timely payments first.
4. Reduce your debt-to-income-ratio.
Your mortgage underwriter could use your debt-to-income ratio, or the percentage of your income that goes toward paying debts, to evaluate how much additional debt you can handle and how much of a credit risk you pose. According to the Consumer Financial Protection Bureau, studies have shown that borrowers with a higher debt-to-income ratio are more likely to run into trouble making monthly payments. If you’re already using most of your income to pay off debt, lenders may not trust that you’ll be able to make your mortgage payments on time and either decline your application or penalize you with high interest rates.
If you want to lower your debt-to-income ratio, you can either increase your income or lower your debt payments. Making more money may seem easier said than done, but there are multiple ways you can do so. Think you’re doing great work? Consider asking for a raise. Have some extra time on your hands? See if you can make some money during your spare time. A little money could go a long way in lowering your debt-to-income ratio.
Also try to pay down your credit card balances. Not only can this help lower your debt-to-income ratio, but it could also improve your credit health.
5. Practice caution when applying for more credit.
Since you want your credit score to be as high as possible when the mortgage underwriter is making a decision, consider holding off on applying for more credit until after everything is finalized. Each credit application could result in a hard inquiry that could potentially lower your score, so it’s important to question whether you really need the extra credit immediately or whether it can wait.
The Bottom Line
Remember, it could take a while to improve your credit. Huge score jumps don’t usually happen overnight, so it’s important to start working on your credit as soon as you start thinking of buying a home. Don’t pay more interest than you have to. By educating yourself and putting some effort into making your credit score the best it can be, you could save yourself a lot of money.
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I completely agree and have 2 professional photographers to make your house look the best it possibly can.