Understanding how to refinance intelligently

The landscape of mortgage refinancing is shifting, but that shouldn’t necessarily scare homeowners away from considering this financial move.

According to the Ohio Credit Union League’s 2018 Mid-Year Consumer survey, 57 percent of respondents have refinanced a mortgage. And most Ohioans, 81.7 percent, believe the best reason to refinance a mortgage is to take advantage of better interest rates, payments, or loan terms.

Fewer Ohioans are comfortable utilizing a cash-out refinance option to pay for home improvements (8.6 percent), to pay off higher debt (6.7 percent), or to pay for a big purchase (1 percent).

Conventional wisdom says respondents have the right idea about the most beneficial use of refinancing. It’s typically considered a better idea to refinance to save money on the loan, rather than use the equity in a house for debt or purchases.

A common way to save money through refinancing is to find a loan with a lower interest rate, but that method may be more difficult to find these days. The improving economy has led to increasing interest rates on a variety of loans, including mortgages, noted a recent report from Back Knight, a real estate data provider.

According to Freddie Mac, a 30-year fixed-rate mortgage had an average interest rate of 4.59 percent in May. That’s an increase of 0.58 percent over last year and a rise of nearly a percentage point since May 2016. The country is still enjoying a relatively low mortgage rate environment – the same loan had an average rate of about 6.04 percent in May 2008 and a whopping 16.4 percent in May 1981.

But, the gradually rising rates does mean fewer Americans have the incentive they need to refinance to a lower mortgage rate. According to an Investopedia article, consumers have historically been guided to look for a 2 percent interest rate decrease before refinancing. Today, some investors say 1 percent is enough of an incentive.

With interest rates climbing in the first six weeks of 2018, those rates are becoming increasingly difficult to find. But the key to successful refinancing, even in a rising-rate environment, is for consumers to look carefully at their individual situation. Falling interest rates may be a common reason to refinance, but it isn’t the only one.

For example, if the homeowner originally opted for a 30-year loan with relatively small monthly payments, but is now in a better financial position to make more substantial payments each month, it might make sense to refinance to the mortgage with a shorter term. The interest rate might not be significantly lower, and monthly payments may increase, but the customer will save money on interest over the shorter lifetime of the loan.

Perhaps a current loan is structured to include a balloon payment at the end, and the homeowner wants to refinance to restructure the loan terms. Or, consumers may have a genuine interest in putting the equity in their home to use to pay off debts or pay for home improvement projects, in which case a cash-out refinance would be attractive.

Consumers shouldn’t discount refinancing their mortgages solely because of rising interest rates. Here are some tips for smart refinancing.

  • Be sure refinancing is the right choice for you. Refinancing isn’t the best option in every situation. Before considering refinancing your mortgage, make sure you know the rate and term of your current mortgage, as well as how that compares to present rates at various terms in the market. It’s important to understand how much you stand to save by refinancing before making the decision.
  • Understand why you’re refinancing. Make sure you have a clear goal in mind for your refinance. If you need to free up money in the short term, you may want to consider shopping for a loan with a significantly-lower interest rate or monthly payment. If you can afford larger payments each month, and want to save over the life of the loan, shopping for a shorter-term loan may make more sense.
  • Raise your credit score. Make sure your credit score is in good shape before deciding to refinance your mortgage so you can get the best possible interest rate. A credit score in the mid-700s will serve you well. To raise your credit score, pay down credit cards, make on-time payments, and avoid taking on new debt before refinancing.
  • Shop for the best loan originator. There’s more to take into consideration than your new loan’s interest rate. Make sure you’re shopping around for institutions offering the best loan origination and document fees. It can also be valuable to search for a loan agent you trust to help you find a mortgage loan that best serves your financial position.
  • Buy mortgage points. Homeowners can buy mortgage points, also known as discount points, to reduce their interest rate. Mortgage points are fees paid directly to the lender at closing in exchange for a lower interest rate. One point costs 1 percent of your mortgage amount – so $300 on a $30,000 loan. “Buying down the rate” basically allows you to pay some interest up front to achieve a lower rate over the life of the loan.

Credit unions are uniquely equipped to help members understand how to find the best loan for them. To find a credit union near you, visit asmarterchoice.org.

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