It’s not a bad idea to consider refinancing your mortgage when interest rates are low, and right now, they are plummeting. In January 2021, mortgage rates had dropped to 2.65%, their lowest point since July 2016. However, at some point, they will inevitably start to rise again. How should that affect your decision to refinance? That, of course, depends on the interest rate you are currently paying on your mortgage.

Even in times of rising rates, an older mortgage could still have a higher interest rate than those currently being offered. Also, with rising rates, it may pay to lock in a current rate if you think rates will rise a lot.

In a relatively low-interest-rate climate, there are both pros and cons to refinancing a mortgage. For example, your improved credit rating–or a decision to change the length of your mortgage–could also bring refinance terms that could save you money in the long run. But maybe you’re not planning to stay for the long run. Some special refinancing programs can be particularly beneficial for those who qualify. Here’s how to work through the decision-making process.

Your individual situation should determine whether or not you refinance your mortgage–not simply whether interest rates are rising or falling.
Advantages of refinancing include getting a better interest rate, increasing your net worth, and boosting your short-term cash flow.
Disadvantages include paying too much on closing costs, winding up with a higher interest rate because you don’t want to pay closing costs, losing equity on a cash-out refinance, and lowering your net worth.
Special programs from Fannie Mae, Freddie Mac, the FHA, and the VA can help certain homeowners secure more affordable mortgages.

In the past, low-interest rates have created a refinancing frenzy in the marketplace. But in any economy, the only way to know if a refinance makes sense for you is to consider the details of your unique situation.

How much should interest rates drop to refinance? That’s not the right question. Instead of listening to “rules” about how much of a percentage change in interest rates you should look for before you refinance, look at how much money you’ll stand to save. A 1% rate reduction is a lot more meaningful if you have a $500,000 mortgage than if you have one that’s $100,000.

As when you purchased your home, you will have to pay closing costs on your refinance. If you’re planning on selling your house in a few years, you may barely break even (or actually come out behind) by refinancing. How come?

If the monthly savings for the remainder of your mortgage are not greater than the closing costs associated with the refinancing, you’ll lose out. If you roll the closing costs into your mortgage instead of paying them up front, you’re paying interest on them, so you’ll need to factor this expense into your break-even calculation.

If you have 20 years left on your mortgage and you refinance into a new 30-year mortgage, you may not save money over the long run (even with a lower rate).

However, if you can afford to refinance that 20-year mortgage into a 15-year mortgage, the combination of a lower interest rate and a shorter term will substantially reduce the total amount of interest you’ll pay before you own the house free and clear.

Pros

Get a better loan

Increase your long-term net worth

Increase short-term cash flow

Cons

Overpaying on closing costs

Overpaying on interest because you want no closing costs

Losing equity

Negatively impacting your long-term net worth

Done properly, a refinance can have both immediate and lasting benefits. You may be able to do the following.

Perhaps you are in a better financial position now than when you took out your existing mortgage. Refinancing may provide an opportunity to get a better interest rate or make a good mortgage even better. Either way, you’ll increase your short- and long-term financial security and increase the odds that hard times won’t put you at risk of losing your home.

With the savings from refinancing your mortgage, you’ll be spending less on interest. That’s money you can put away for retirement or use toward another long-term financial goal.

If your refinance lowers your monthly payment, you’ll have more money to work with on a month-to-month basis. This can reduce the day-to-day financial pressure on your household and create opportunities to invest elsewhere.

Refinancing a mortgage introduces new elements into your financial situation. The risks from your original mortgage are still present, and a few new ones come to the surface.

Unscrupulous or predatory lenders can tack several unnecessary and/or inflated fees onto the cost of your mortgage. What’s more, they may not disclose some of these costs upfront, hoping that you will feel too invested in the process to back out.

A refinance may not require any cash to close. One way lenders make up for this expense is to give you a higher interest rate. Let’s say you have two options: a $200,000 refinance with zero closing costs and a 5% fixed interest rate for 30 years, or a $200,000 refinance with $6,000 in closing costs and a 4.75% fixed interest rate for 30 years.

Assuming you keep the loan for its entire term, in scenario A, you’ll pay a total of $386,511. In scenario B, you’ll pay $381,586. Having “no closing costs” ends up costing you $4,925 over the life of the loan.

The part of the mortgage you’ve paid off, your equity in the home, is the only part of the house that’s really yours. This amount grows little by little with each monthly mortgage payment until, one day, you own the entire house and can claim every penny of the proceeds if you choose to sell it.

However, if you do a cash-out refinance–rolling closing costs into the new loan or extending the term of your loan–you chip away at the percentage of your home that you actually own. Even if you stay in the same home for the rest of your life, you might end up making mortgage payments on it for 50 years if you make poor refinancing decisions. You can end up wasting a lot of money this way, not to mention never truly owning your home.

Refinancing can lower your monthly payment, but it will often make the loan more expensive in the end if you’re adding years to your mortgage. If you need to refinance to avoid losing your house, paying more, in the long run, might be worth it. However, if your primary goal is to save money, realize that a smaller monthly payment doesn’t necessarily translate into long-term savings.

There are a couple of special refinancing programs that may be particularly beneficial to qualified borrowers.

High loan-to-value (LTV) mortgage loans are those in which the amount owed on the mortgage is nearly equal to or exceeds the home’s appraised market value. These high LTV loans are considered high risk to lenders since a default or nonpayment by the borrower could result in the lender losing money if the bank forecloses and sells the home for less than the loan amount given to the borrower.

Unfortunately, Fannie Mae and Freddie Mac have temporarily suspended mortgage loan refinances under the high loan-to-value (LTV) programs. All high LTV refinances must have had their applications dated on or before June 30, 2021, and must be purchased or securitized on or before Aug. 31, 2021. Historically, these Fannie Mae and Freddie Mac programs were designed to replace the Home Affordable Refinance Program (HARP), which expired on Dec. 31, 2018.

HARP was set up to help homeowners who could not take advantage of other refinance options because their homes had decreased in value. Its goal was to improve a loan’s long-term affordability to help prevent people from losing their homes to foreclosure. Only mortgages held by Fannie Mae (High LTV Refinance Option) or Freddie Mac (FMERR) were eligible. Still, they also had to have a loan origination date on or after Oct. 1, 2017, and borrowers had to be current on their payments.

On June 5, 2021, Fannie Mae began to offer low-income mortgage holders a new refinance option through a program called “RefiNow,” meant to reduce their monthly payments and interest rates. Beginning in August 2021, Freddie Mac will offer the exact same program, which will be called “Refi Possible.” In order to be eligible, homeowners must be earning at or below 80% of their area median income (AMI).

Fannie Mae’s RefiNow program offers several benefits for homeowners. First, it requires a reduction in the homeowner’s interest rate by a minimum of 50 basis points and a savings of at least $50 in the homeowner’s monthly mortgage payment. Second, Fannie Mae will provide a $500 credit to the lender at the time the loan is purchased if an appraisal was obtained for the transaction, and this credit must be passed on from the lender to the homeowner.

In order to qualify for Fannie Mae’s RefiNow program, a homeowner must meet these qualifications:

Be in a possession of a Fannie Mae-backed mortgage secured by a 1-unit, principal residence.
Have a current income at or below 80% of the AMI (not the income as of origination of the original loan.)
Never missed a mortgage payment in the past six months and no more than one missed mortgage payment in the past 12 months.
Be in possession of a mortgage with a loan-to-value ratio up to 97%, a debt-to-income ratio of 65% or less, and a minimum 620 FICO score.

Through the Freddie Mac Refi Possible program, eligible borrowers with a Freddie Mac-owned single-family mortgage will benefit from a reduced interest rate and lower monthly mortgage payment, helping save an estimated $100 to $250 a month.

In order to qualify for Freddie Mac’s Refi Possible program, a homeowner must meet these qualifications:

Be in possession of a Freddie Mac-owned mortgage secured by a 1-unit single-family residence that is their primary residence.
Have income at or below 80% of the area median income.
Never missed payments in the past six months, and not more than one missed payment in the past 12 months.
A loan-to-value ratio at or below 97%, a debt payment-to-income ratio below 65%, and a minimum Indicator Score of 620 or higher.

A Federal Housing Administration (FHA) Streamline refinance is designed for homeowners who already have an FHA mortgage. Its goal is to provide a new FHA mortgage with better terms that will lower the homeowner’s monthly payment. The process is supposed to be quick and easy, requiring no new documentation of your financial situation and no new income qualification.

This type of refinancing does not require a home appraisal, termite inspection, or credit report. One possible drawback for some homeowners is that an FHA streamline refinance does not allow cash out.

Mortgage lending discrimination is illegal. If you think you’ve been discriminated against based on race, religion, sex, marital status, use of public assistance, national origin, disability, or age, there are steps you can take. One such step is to file a report to the Consumer Financial Protection Bureau or the U.S. Department of Housing and Urban Development (HUD).

This program, also known as an interest rate reduction refinance loan (IRRRL), is similar to an FHA streamline refinance. You must already have a Veterans Administration (VA) loan, and the refinance must result in a lower interest rate unless you are refinancing from an adjustable-rate mortgage (ARM) to a fixed-rate mortgage. The lender may require an appraisal and a credit report, though the VA does not require these.

Notably, the VA and the Consumer Financial Protection Bureau issued a warning order in November 2017 that service members and veterans had been receiving several unsolicited offers with misleading information about these loans. Check with the VA before acting on any offer of a VA IRRRL.

With both the VA streamline and the FHA streamline, it is possible to pay few to no closing costs upfront. However, these costs will either be rolled into the mortgage, or you’ll pay a higher interest rate in exchange for not paying closing costs. So while you won’t be out any cash upfront, you will still pay for the refinance over the long run.

Any good refinance should benefit borrowers by lowering their monthly housing payments or shortening the term of their mortgage. Unfortunately, as with any major financial transaction, some complexities can trip up the unwary buyer and result in a bad deal. Knowing about the process will help you find a lender and a refinancing program that offer the best value for your situation.


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