You can Save Money with a Refinance
If you’d bought a house between 1979 and 1990, you would be hard pressed to get an interest rate under 10 percent. Today, those rates are unimaginable. Looking at the last several years of mortgage loan rates, and how low they have been, we’re shocked that the economy could tolerate the rates from just a few decades ago.
Interest rates have risen slightly in the last year, but if you have a home loan, you may be able to save money in the long term by refinancing. Sometimes that even means refinancing to an interest rate that isn’t a whole lot different than where you are at now. Here is how you can save.
Wiping out the PMI
PMI, or Private Mortgage Insurance, can eat into your finances quickly. This insurance protects the lender in case you default on the loan, and in most cases, it is required if you have less than 20 percent equity in the home. It costs around 1 percent of the loan value, every single year. So if you buy a $200,000 house without a down payment, you will end up spending $2,000 per year, or $166 per month, on PMI.
Let’s consider the savings with a refinance. Suppose your original loan was a 30-year loan at 4.5 percent. On a $200,000 house, you pay $1,179 per month (including PMI, principal, and interest). If you’re three years into the loan, then you still owe $192,000 (based on amortization rates). If you refinance at the same interest rate as before, your payments lower to $973; a $206 per month savings. Depending on your closing costs of the new loan, you will be ahead in as little as two to three years.
Dropping a Percentage Point
Mortgage rates change every day. In fact, they can often change several times throughout the day. According to the Federal Reserve, rates (at the time of writing) were 4.8 percent for good credit. Two weeks ago, they were 4.9 percent; two months ago, they were closer to 4.5 percent. While they are trending upward, they are still a lot lower than what you may have gotten locked into. This is especially true if your credit has improved since you first took out the loan.
Let’s suppose you took out your mortgage three years ago at 5.5 percent. Using our $200,000 example, that means your payments (principal and interest only) would be $1,136 per month. After three years you still owe $194,000 on the home, and you refinance to 4.5 percent interest. Your new monthly payments drop to $983, a savings of $153 per month.
Keep in mind, when you refinance your term starts over, so you have three more years to pay on the loan.
Fix Your Credit for the Best Terms
Your credit score gives lenders a quick reference on how likely you are to pay your bills on time, or how likely you are to default. Based on how you have used credit in the past gives them a good indication of how you will use it in the future.
Tip: If you need help finding out exactly what your credit score if, visit Credit Sesame. You will be able to receive access to your credit score for free.
Because a lower score means you are more likely to default on your loan, the lender is taking on more risk to give you a loan. To compensate for this greater risk, they charge higher interest to those with lower credit scores.
If your credit score is in the subprime category (620-639) you can expect to pay interest rates over six percent (rates as of the time of this writing). But if you have credit in the excellent category (760 – 850), your rates will be about 4.5 percent. You can check out more details on MyFico.com to learn how your score affects what you pay.
Raising your credit score just 20 points can save you thousands of dollars over the life of the loan. And if you do a little credit repair at least a few months before refinancing, it is likely that you can see a dramatic improvement in your score, and thus an improvement in the amount you have to pay.
Every Loan is Different
Will a refinance work for you? It all depends on your goals (how long will you live in the house?), your situation (what is your income level and credit score?), and current rates (they change often). So there really isn’t one answer that can say you will save money.
If you are still paying Private Mortgage Insurance, or your interest rate is higher than the current rates, it may be in your best interest to look into a refinance. This especially true if you have repaired your credit and your score has gone up since the last time you took out a loan.
