Two weeks ago, I explained mortgage forbearance – a delay in mortgage payment because of COVID-19 – and how to apply for it. Today, I want to discuss refinancing a mortgage and why it may make sense to do it now.
Homeowners refinance for several reasons: lower monthly payments; reduced interest charges; paying off mortgage sooner or later; and access to the equity in a home.
Because of the pandemic, interest rates are at an all-time low. How long they will remain at these levels is unknown, but as the economy recovers, interest rates will rise. When deciding to refinance a mortgage, some basic terms should be known.
Closing costs: There are fees paid at the closing of a real estate transaction.
Mortgage points: Also known as discount points, these are fees paid directly to the lender at closing in exchange for a reduced interest rate.
Fixed rate: This means the interest rate remains constant throughout the length of the loan.
Variable rates: These mean the interest rate changes periodically, tying it to some financial index.
Term: This is the length of the loan.
Equity: It means the amount of value in your home minus any mortgages.
Understanding words used in a mortgage makes it easier to navigate refinancing. Understanding some basic principles of lending also will help.
First, the better your credit score, the lower the interest rate. The longer the mortgage term, the higher the interest rate. Variable rates usually have lower rates because the rate changes periodically.
OK, now that I have educated you on terms, here is how they fit together.
There are two ways of lowering your monthly mortgage payment: Refinance at a lower interest rate or refinance at a longer term.
The ideal way is refinance at a lower interest rate and reducing the term (length) of your loan. The ideal way rarely happens, but that doesn’t mean you shouldn’t try. One thing you should consider is how long you plan to stay in your home.
Contact a mortgage lender, who will need to know the amount you owe on your mortgage and how many years you have to pay on it. If you borrow the same amount and add to it any closing costs, and if the term is the same as the years left to pay on your mortgage and your new payment is lower, then go for it.
If lowering your monthly payment is your goal and you plan on staying in your home for a long period, going for a longer term may help you reach your goal. Lower interest rates, plus a longer term, plus new closing costs may cost you more over time, but may give you cash flow to enjoy other things.
If you desire to pay your mortgage off sooner, lower interest rates may enable you to shorten your term with the same monthly payment or a payment you can afford, while reaching the goal of mortgage-free home. People planning to retire may want to consider this approach.
One of the most common reasons people refinance their mortgage is to gain access to the equity they have built over time. Each mortgage payment you make applies an amount to principle. Inflation increases the value of your home.
Ten or 15 years of steady mortgage payments, plus inflation, increased the equity of your home. The reason to access this equity is personal – home repairs, student loans, paying off credit cards or that dream vacation.
The reason does not matter. What does matter is timing and now is the best time to refinance your mortgage.
On a personal note, four weeks have passed since we started our “Here to Help Project,” raising funds for six local charities plus matching the first $15,000 in contributions. After three weeks, we were halfway there – $7,500. Just send a check to the Washington County Community Foundation with the words “Here to help” in the memo line.
Bob Hollick is a State Farm Insurance agent based in Washington. His column now will appear every other Thursday in the Observer- Reporter.
To submit columns on financial planning, investing or business-related matters, email Rick Shrum at email@example.com.