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By Aly J. Yale
December 15, 2020
Money; Getty Images

Homeowners refinanced in droves this year — and it’s no wonder. With mortgage rates dropping to an all-time low of just 2.71% at one point, the financial incentive — at least for many homeowners — was huge.

On a $200,000 mortgage, for example, refinancing from a 4.25% rate to a 3% one — a rate higher than today’s current average, according to Freddie Mac — homeowners could shave $140 off their monthly payment and a jaw-dropping $88,000 over a 30-year loan term. For those who had loans from 2009 or earlier, when rates rarely dipped below 5%, the savings could be even bigger.

Fortunately, it seems the low rates are here to stay — so if you weren’t one of the millions who seized the day this year, there’s still time. In fact, most experts predict an average rate of anywhere from 2.9% to 3.4% across the new year.

Are you thinking of pulling the trigger? Here are the steps you’ll need to take if a New Year’s refinance is on your agenda:

1. Run the numbers.

The first step is to make sure that refinancing actually makes sense. For one, a refinance doesn’t come for free. According to Freddie Mac, it costs an average of $5,000 to refinance a mortgage loan or about 2% to 5% of the total loan amount.

To make those costs worth it, you’ll need to reach the break-even point — which is when the refinance saves you more than it costs to execute.

Calculating that break-even point requires a few bits of information: First, an idea of how long you’ll be in the home; second, an estimate of your closing costs; and third, how much you’ll be saving each month by refinancing. You can get a sense of potential savings using an online mortgage calculator or by working with a mortgage broker or loan officer. They can help walk you through the numbers, as well as what interest rate you might be able to expect.

Your break-even point is then calculated by dividing your closing costs by your monthly savings. If you’re closing costs are $4,000 and you’re saving $50 per month, then your break-even point is 80 months (4,000 / 50). So essentially, it would take you 80 months — or more than seven years — to break even on your refinancing costs. If you don’t plan to be in the home that long, then refinancing isn’t financially worth it.

“With any potential refinance, borrowers should make sure they fully understand the potential costs and savings associated with the refinance to assure the economics make sense,” said Mike Tassone, co-founder and COO at mortgage marketplace Own Up. “Unfortunately, there are some lenders that will encourage consumers to refinance, even if it’s not necessarily in their best interest.”

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2. Know your goals.

You also need to know your objectives before refinancing your mortgage loan. Though most homeowners are looking to lower their mortgage rates and save on monthly payments when refinancing, there are other goals you can achieve, too.

For one, you could use a refinance to pay off your loan faster. To do this, you’d refinance into a shorter-term loan — for example, from a 30-year mortgage to a 15-year one. Your monthly payment would be higher, but it would also ensure your loan is paid off sooner — and save you on long-term interest, too.

You might also use a refinance to take cash out of your home and pay for home improvements, consolidate debts or handle other costs. In some cases, you may want to change loan types — say, from an adjustable-rate mortgage to a fixed-rate one.

“Review different refinancing options,” said Sonu Mittal, head of retail mortgages at Citizens Bank. “​The most common reasons folks will consider refinancing are to reduce their rate, pay off other debt through a cash-out refi or their current loan is maturing and need to refinance into a long-term product.”

Ultimately, your goal will determine what loan type you will need, as well as the qualifications you’ll need to meet.

3. Get your documentation together.

Refinances require a good amount of financial paperwork, just as your initial mortgage loan did. That means you’ll need papers that prove your income, debts and other financial obligations.

“Take inventory and begin gathering the documents you will need during the underwriting of your loan,” Tassone said.

If you’re a salaried worker, that includes the last 30 days of pay stubs, the last two years of W-2s, a two-year employment history, copies of your recent mortgage and property tax statements and a copy of your homeowner’s insurance declarations page.

For those with non-traditional jobs, you may need bank statements, 1099s, recent client invoices and a profit-and-loss statement for your business. Getting these all in order early can help your refinance go more smoothly once you’re ready to apply.

According to Tammy Andrews, vice president and branch manager at Motto Mortgage United, you should also know your home’s estimated value and your current mortgage loan balance before applying for a refinance. The difference between your home’s value and mortgage balance is your home equity, which acts as your down payment in a refinance. The amount of equity you have will influence your overall loan eligibility, your interest rate and the amount of cash you can access when doing a cash-out refinance. It will also determine if you need private mortgage insurance.

4. Keep a close eye on your credit — and maybe try to improve it.

“Your credit score will play a significant role in getting you the best rate possible,” Mittal said.

It will also impact your ability to qualify for a refinance in the first place. To make sure your credit is in a good place, pull your credit report (all three credit reporting bureaus will let you do so for free once a week through April) and look for any blemishes — things like late payments or collections attempts. These will need to be remedied before you apply for a loan.

You should also be careful about your holiday spending. Avoid opening new credit cards (including store ones), and steer clear of racking up balances on existing cards. Both of these actions can lower your credit score, making it harder to get a loan. They can also increase your debt-to-income ratio — how much of your monthly income your debts take up.

“Borrowers should be mindful of opening new credit accounts, as these will increase the monthly debt-to-income ratio — which is a key qualifying factor,” Tassone said. “If a borrower absolutely needs to open additional credit, they should confirm with their lender — prior to doing so — to determine the impact on their mortgage qualification.”

Finally, you can also try to actively increase your score before applying, too. Paying down your debts, making on-time payments and alerting credit bureaus of any errors on your report can all help here.

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5. Avoid or delay applying for mortgage forbearance.

If you’re having a hard time making your mortgage payments during the pandemic, forbearance can give you a break — at least temporarily — until you get on your feet. According to the Mortgage Bankers Association, about 5.48% of American mortgage loans (or 2.7 million homeowners) are currently in forbearance, essentially pausing their monthly payments for up to 360 days.

Though this can certainly help lighten the load during hard financial times, it can also hurt your chances of refinancing.

“Borrowers should not request a hardship forbearance from their current lender before attempting to refinance,” Tassone said.

For one, since refinancing can lower your rate and monthly payment, it could help you avoid forbearance altogether. If you need to file for forbearance later on, it would also reduce the amount of those deferred payments, making it easier to get current down the line.

Additionally, there’s your credit report to think about. Though the move won’t hurt your credit score directly, it will get noted on your credit report as a delinquency, which new lenders will see when evaluating your application. At best, it could give them pause about loaning you money. At worst? It might mean an outright denial, Tassone said.

The same goes for forbearance options on other debts, too — including those on car loans, student loans or other debt you might have in your name. If you’re considering pausing payments on any loan leading up to your refinance, talk to a mortgage pro first about your options. You could also ask your existing lender about a loan modification, which may let you change the rate and terms of your current loan without refinancing.

If you’re already on a forbearance plan, don’t fret. You’ll be eligible to refinance after you’ve made three on-time payments.

6. Shop around for your lender.

You don’t have to use your current lender to refinance — nor should you. Rates and qualifying standards vary wildly from one mortgage lender to the next, so shopping around is critical. According to a study from the Consumer Financial Protection Bureau, rates can differ as much as .50% between lenders — even for the highest-credit borrowers.

“The key to securing the best interest rates is to shop around,” Tassone said. “We regularly encounter consumers who are able to substantially improve their rate simply by receiving multiple quotes.”

It’s true: Recent data from loan marketplace LendingTree shows that refinance borrowers who shopped around last quarter will save as much as $59,255 across their loan term. Freddie Mac data shows that borrowers who get at least two mortgage quotes save around $1,500. Those who get five quotes? The savings jump to $3,000.

It’s more than just a cost-saving measure, though. Shopping around between mortgage lenders (credit unions, big banks and online lenders), as well as mortgage brokers (essentially personal shoppers for mortgage borrowers) can have other benefits, too.

“Each will look at your mortgage application differently and offer you varying levels of service and options,” Andrews said. “Remember, rate isn’t everything. You will want to have a trustworthy, reliable point of contact to answer your questions, help you stick to deadlines and navigate all of the documentation to close the refinance on time.”

When shopping around, it’s important to get all your quotes within a 30-day period or less. Since lenders will require a hard credit check with each application, applying within a short time frame reduces the impact they’ll have on your score.

7. Lock your rate.

If a lender makes you an offer that achieves your goal, then it’s time to lock your rate, which guarantees that quoted interest rate for a period of time — usually 30 to 60 days. This protects you from any rate increases while the lender processes your loan.

According to Tassone, locking your rate is critical once you find a deal you like.

“Interest rates change daily, as do the potential savings from a refinance,” he said. “Once consumers have decided they want to move forward with a rate quote they have received, they should request their lender lock that rate so they’re not subject to future rate fluctuations.”

Shorter lock terms generally come with better interest rates, Andrews said, so ask the lender about your options. Be careful, though. You’ll want to make sure the lender can actually close the loan on that shorter timeline. If they can’t, you may owe a fee to extend the lock or, riskier yet, you might have to take whatever market rate is available when your lock expires. According to mortgage tech firm Ellie Mae, on average it took 57 days to close a refinance loan in October — over two weeks longer than a year earlier.

“Given the pandemic and historically low interest rates, borrowers should plan for lenders to take up to 60 days to approve and fund their application,” Tassone said. “Borrowers should ask their lender whether their lender will extend the rate at their cost if they can’t close the loan within this timeframe.”

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If a refinance is on your radar for early 2021, you’ll want to get the ball rolling today. Mortgage rates are at their lowest point ever right now, and though experts largely expect low rates to continue, there’s no predicting the future.

As Andrews explained, “We’re in an environment where the early bird gets the worm.”

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