Best Mortgage Refinance Rates
Are you thinking about refinancing your mortgage? With rates being near historic lows, now is certainly an outstanding time to make the move. But even in a very low interest rate environment, there are a few things you need to know – and do – to get the best refinance rates.
You deserve to get the lowest rates possible, but that may require some advance preparation. In this guide, I’ll show you exactly how to make that happen.
Want to know how to get the best refinance rates? Let’s dive in and find out.
IN THIS ARTICLE:
Compare Today’s Best Mortgage Refinance Rates
Here are some of today’s best mortgage refinance rates:
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More terms/types available including FHA, VA, USDA and more
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How to Get the Best Refinance Rates
Since a home mortgage is a large, long-term debt, you owe it to yourself to get the best refinance rates. After all, the whole point of a refinance is to create a net improvement in your overall financial situation.
Fortunately, there are 5 steps you can take to get the best refinance rates.
- Improve Your Credit Score
- Lower Your Debt-to-Income
- Refinance the Minimum Amount
- Reduce Closing Costs
- Compare Lenders
1. Improve Your Credit Score
Mortgage loans are based on what’s known as tiered pricing. That’s a system in which interest rates are adjusted for different factors. This can include the size of the loan, the loan-to-value (the amount of the loan divided by the property value), the type of property (second home, condo, multifamily, etc.), and other factors.
But probably the single biggest factor affecting your mortgage refinance rates will be your credit score.
How important is your credit score in determining mortgage refinance rates? According to the website myFICO.com, the effect of different credit score ranges on your mortgage rate look something like this:
Average rates for 30-year fixed $300,000 mortgage
|FICO score||APR||Monthly Payment|
Notice that the difference in interest rates between the highest credit score range and the lowest is more than 1.5%. That translates into an increased monthly payment of $274, or nearly $3,300 per year on the same $300,000 mortgage.
This screenshot hopefully will provide you with the motivation necessary to do what you can to improve your credit score before applying for a mortgage. Dispute any errors on your credit report, pay off any past due balances, and either pay down some debts, or pay off (but don’t close out) some small credit card balances.
All will increase your credit score, hopefully enough to move you into a credit score range that will get you the best mortgage refinance rates available.
2. Lower Your Non-Housing Debt
Another factor refinance mortgage lenders look at when setting your interest rate – or even approving your loan – is what’s known as your debt-to-income ratio, or “DTI.” This is the combined amount of your monthly housing payment – principal, interest, taxes, and insurance – plus fixed, recurring monthly debt payments divided by your stable monthly income.
Let’s say your stable monthly income is $5,000. Your projected monthly house payment is $1,200, and your total non-housing debt payments are $600. That means your total monthly obligations are $1,800. When divided by your stable monthly income of $5,000, your DTI will be a very acceptable 36%.
Generally speaking, mortgage lenders will allow your DTI to go as high as 43%. In some cases, they’ll approve your loan even if it’s higher. But a higher DTI may also result in a slightly higher interest rate on your loan.
You can help your cause by paying off any non-housing obligations before applying for a refinance. Not only will this help you in the rate department, but paying off debt also helps increase your credit score. The combination of both will give you the best shot at the lowest possible mortgage rate.
3. Keep the New Mortgage Amount to a Minimum
Never get carried away with borrowing against your home on a refinance. It’s a surprisingly easy thing to do. Your primary goal may be to refinance your existing mortgage into a lower interest rate. But an overly aggressive mortgage representative may also sell you on the idea of taking out “a few thousand dollars more” for non-housing related purposes.
Apart from the equity stripping factor that we’ve already discussed, cash out is another pricing tier factor. Generally speaking, your interest rate will be increased slightly if your refinance involves taking cash out for non-housing purposes, even if it’s only for a few thousand dollars.
Avoid the Additional Cost of PMI
But there’s an even bigger reason to keep your new mortgage amount to an absolute minimum, and that’s the possibility of requiring private mortgage insurance, or “PMI.”
On conventional mortgages and even on most jumbo loans, PMI will be required any time the new mortgage amount exceeds 80% of your home’s value.
Mortgage insurance is not to be confused with homeowner’s insurance, which provides reimbursement for damages sustained to your property. But the purpose of PMI is to minimize the loss to your lender should you default on the loan. If you do, the insurance company will reimburse the lender for a percentage of your outstanding loan balance.
Since loan amounts greater than 80% of the value of the property are statistically much more likely to default, lenders require PMI to make the loans.
PMI isn’t cheap – it could add hundreds or thousands to the annual cost of owning your home. For that reason, do everything possible to keep the amount of your refinance at 80% or less of your home’s value.
To add insult to injury, your lender will increase your rate by a tick if the loan is greater than 80%.
4. Keep a Close Eye on Closing Costs
The general range on closing costs in the mortgage industry is between 2% and 3% of the new loan amount. Once again, on a $300,000 refinance, that will translate into closing costs between $6,000 and $9,000.
Your mission will be to keep those closing costs on the lower end of the range. Closing costs on a refinance can either be paid out of pocket – which will require a fresh investment into your home – or rolled into the new loan. That will increase your loan amount, as well as your monthly payment.
But there is a third option. Even after you locate a mortgage lender that charges at the lower end of the range, you can always opt for what is known as lender pay closing costs. That’s where the lender will pay your closing costs in exchange for a slight increase in your interest rate.
The conversion is something on the order of a 1/8 (0.125%) increase in your interest rate will buy 1% toward closing costs. If the closing costs will be 2%, the lender can cover them all with a 0.25% increase in your interest rate.
If you are currently paying 4.5% on your loan, but the lender will cover your closing costs by increasing the rate on the new loan from 3.75% to 4.00%, you’ll get the benefit of a half-point reduction in your interest rate, but without having to pay any money out-of-pocket.
That kind of refinance almost always make sense.
5. Shop Between Lenders
There’s usually not a whole lot of difference in base interest rates between mortgage lenders. Lenders get their mortgage funding from the same three sources; the Federal National Mortgage Association (“Fannie Mae”), the Federal Home Loan Mortgage Corp. (“Freddie Mac”), or from the Government National Mortgage Association (“Ginnie Mae”) for FHA and VA loans.
The main difference in rates has to do with annual percentage rate, or APR. APR is the effective rate you’re paying when closing costs are factored into the mix.
If you see one company with an APR of 3.88%, and another with 3.72%, it’s likely the first lender has higher closing costs.
It works something like this: Again, using our example of the 2% to 3% closing costs range on a $300,000 mortgage, the dollar amount can range from $6,000 to $9,000.
If you take a loan for $300,000 and pay $9,000 in closing costs, you’re only really getting $291,000. But when the closing costs are $6,000, you’re actually getting $294,000.
When the monthly payment on each loan is applied to the net loan amount, the APR will be higher on the loan with higher closing costs, because the net loan amount is lower.
Never let anyone try to convince you that APR is just a technicality. It was instituted specifically to make it easier for consumers to compare rates between lenders that also reflect closing costs.
Why Refinance Your Mortgage?
There are four primary reasons anyone refinances their mortgage:
- The benefit of a lower interest rate and/or monthly payment
- To consolidate a first and second mortgage, or to take cash out of your home
- Converting from an adjustable-rate or a balloon to a fixed-rate loan
- To increase or decrease the loan term
The first three reasons are self-explanatory, but the last needs some additional discussion. In most cases, this involves reducing your loan term, typically from a 30-year loan to a 15-year loan.
The basic motivation is to pay off your mortgage early, eliminating your monthly payment and saving yourself many thousands of dollars in interest in the process.
However, in some cases, homeowners will choose to increase the loan-term. Though it’s a less common strategy, there’s actually solid logic behind it.
Borrowers are often drawn to the 15-year mortgage because of its shorter-term and slightly lower interest rates. And while those are certainly valid reasons to take the shorter-term loan, it comes with a price. That price is a higher monthly payment. After taking a 15-year mortgage, some homeowners decide they prefer the lower monthly payment that a 30-year mortgage provides.
30-year Mortgage vs. 15-year Mortgage
Let’s work an example to make a point.
You need to take a mortgage for $300,000, and you’re debating taking a 30-year or a 15-year loan. The 30-year mortgage, at 3.75%, has a monthly payment of $1,389.
But the 15-year mortgage has a slightly lower rate at 3.5%. The monthly payment is $2,144. Choosing the 15-year mortgage will require a monthly payment that will be higher by $755.
Now the benefits of the 15-year mortgage are clear, but the (much) higher monthly payment may prove unexpectedly difficult to manage since the higher monthly payment will apply for all of the next 15 years. The often unanticipated limitation of the 15-year mortgage is that all the benefit occurs at the end of the loan. Between now and then, you’ll be saddled with the (much) higher monthly payment.
Some homeowners choose to refinance from a 15-year mortgage into a 30-year mortgage to lower the monthly payment. This may be necessary if the household experiences either a decrease in income, an increase in expenses, or a combination of both. It may also be a good strategy if one or more members of the household is changing careers or launching a business that may result in a reduced income for several years.
When Refinancing Your Mortgage Doesn’t Make Sense
In general, homeowners are interested in refinancing whenever there is a significant reduction in mortgage rates, compared to their current interest rate. But lower rates don’t always make refinancing an automatic decision.
There are at least three circumstances where you may not want to refinance.
1. You only have a few years left on your current mortgage
Let’s say you currently have a rate of 4.5% on a mortgage with seven years left. It may not make any sense to refinance into a 3.5% rate on a 15- or even 10- year loan. That’s because extending the term is very likely to offset the interest savings from the refinance. As well, there’ll be closing costs for the refinance, that will at least partially negate the interest rate savings. The better strategy may be to simply increase your monthly payments, and pay off your current mortgage even faster.
2. The cost of the refinance will outweigh the savings
You can generally expect a refinance to generate closing costs equal to between 2% and 3% of your new loan amount. If the loan amount is $300,000, it could result in between $6,000 and $9,000 in closing costs. For this example, let’s take the midpoint at $7,500.
Your current $300,000 loan has an interest rate of 4.75%, which you could refinance into a new 30-year fixed rate loan at 3.75%. If you do the refinance, you’ll lower your monthly payment from $1,564 to $1,389. The monthly savings will be $175.
Mortgage experts recommend refinancing based on the closing cost recovery term. That’s the dollar amount of your closing costs, divided by your monthly savings.
In this case, you’ll have closing costs of $7,500, which, when divided by $175 per month, comes to nearly 43 months.
A closing cost recovery term of two to three years is considered the industry standard. But in this case, the recovery period will be a little bit greater than 3.5 years. Because so much can happen in that space of time, it’s possible you may not live in the home long enough to recover the cost of the refinance.
3. You want to refinance to take out equity for basic living expenses
Homeowners who are struggling to live within their means will often use credit as a way to make up the difference. But this is when it’s important to realize that taking equity out of your home for short-term financial needs puts your home at risk.
This often takes the form of refinancing to pay off credit card debt and other forms of unsecured credit. Basically, you’re borrowing against your home to pay for past budget shortfalls, a process known as equity stripping. It seems to work when property values are rising reliably. But if they flatten out or decline, the whole strategy works in reverse. If taken to the extreme, you can find yourself owing more on your home than the property is worth.
Refinancing to take equity out of your home to pay for short-term living expenses is nothing more than putting off the day of reckoning on an unbalanced household budget. And it’s one of the worst reasons for refinancing.
Mortgage Refinance Tips
If you’re contemplating a refinance, there is some additional advice you may find helpful:
Fixed rate mortgages are better than adustable rate mortgages for most homeowners
Adjustable rate mortgages (“ARMs”) start out with a fixed term – typically three-, five-, seven-, or ten-years. Once the fixed rate term has ended, they become one-year adjustable rates. Upon each adjustment, the rate will likely change. They usually have caps to protect you from the worst outcome. A common lifetime cap is 5%, which means a loan that starts out at 3% can never adjust higher than 8%.
These loans are best avoided in favor of fixed rate mortgages, partially because fixed rates guarantee both your rate and your payment for the life of the loan. There’s virtually no possibility of an increase in either. But it’s also important because the spread between fixed rates and ARMs is so narrow, typically less than 0.50%. It may not be worth it to take a higher risk of the ARM for such a small benefit.
But perhaps most important is you can’t be certain you’ll be selling your home or refinancing the loan within a fixed term of the ARM. If you can’t, you’ll be subject to potential rate increases in the future.
Avoid paying discount points
A lender may offer you an opportunity to lower your interest rate by paying what is known as discount points. The current conversion is approximately 1 point to lower your interest rate by 0.125%. The out-of-pocket cost is unlikely to justify such a small decrease in your rate.
A 30-year mortgage provides greater flexibility than a 15-year mortgage
You don’t necessarily have to take a 15-year mortgage to pay off your loan early. You can take a 30-year mortgage, and make the equivalent monthly payments based on a 15-year payout. If, at any time along the way you experience a cash flow problem, you can always revert to the original, lower payment based on the 30-year term.
Taking the 30-year mortgage may also eliminate the potential need to refinance from a 15-year mortgage to a 30-year to lower the monthly payment on a permanent basis. Simply put, a 30-year mortgage offers greater options in the long term.