Homebuyers

Ready, Set, Refinance: What Homeowners Can Do to Get Ready to Refinance When Interest Rates Drop

If you’ve been checking your inbox for that “your rate might have just dropped” alert, smart - because rates are dropping.

Even a small mortgage interest rate drop, say, from 6.8% to 6.35%, could open the door for millions of homeowners to save by refinancing their mortgages.

Still, refinancing isn’t as simple as hitting “refresh” on your lender’s website. The opportunity may be approaching, but the time to prepare is now.

“Homeowners need to be ready for refis as well as sellers who would be buyers but for high interest rates,” said Jeff Lichtenstein, CEO and broker at Echo Fine Properties in Palm Beach Gardens, Fla. 

Here is what you need to know so you can act quickly when the numbers work in your favor.

Make sure refinancing your mortgage saves money

Before you apply for a refinance, make sure it will wind up saving you money over the short- and long-term. You may also want to refinance to shorten the length of your loan.

“There’s an old myth that you shouldn’t refinance unless you can lower your rate by at least full percentage point drop,” said Brenda Dintino, branch manager at New American Funding in Tustin, Calif.

However, if your lender can do a no-cost refinance, which waives or credits the lender fees, “even a quarter-point drop can make sense,” said Dintino.

Remember, you can “lock” a rate once you apply. Lock periods typically last 30 to 60 days, which can protect you if rates tick back up before closing.

But if you will have to pay a lot in fees, not every dip in rates is worth chasing. Most experts advise that you should see at least a half-point to a full percentage point drop before you start the process. A 0.25% change typically won’t be sufficient once fees are factored in.

Also, don’t just look at the rate, look at your own timeline. Make sure you figure out how much the refinance will cost and how long you will need to live in your home before you pay that off and start enjoying those savings.

Use online calculators to plug in your current balance, rate, and the new loan terms you’re considering.

Look at the monthly savings and divide the closing costs by that number. That’s your breakeven point.

If it’s 24 months and you know you’ll be in the house for five years, a refinance may be a smart move. If you’re planning to sell in 18 months, a refinance may not make financial sense for you.

Clean up your credit before applying for a refinance

If your credit score has been coasting, now’s the time to give it a tune-up. A higher score can translate into a lower mortgage interest rate, which may save you thousands over the life of the loan.

Lenders typically require scores in the mid-600s or higher. The best rates are often reserved for borrowers in the 740-plus range.

“Meet with a mortgage [lender] now,” said Lichtenstein. “Let them run your credit and see where you are at. Most likely, if you haven’t looked at it in a while, you’ll have some credit issues, and credit repair takes time.”

Pay down balances where you can. And put a pause on new credit applications, for things like credit cards or large purchases, until the refinance closes. Those hard inquiries can nick your score right when you need it in peak form.

Pull together paperwork to refinance your home loan

Applying for a refinance looks a lot like applying for your first mortgage. Take the time to gather the following documents so they are readily available when you are ready to refinance:

• Pay stubs from the past two months
• W-2s or tax returns for the last two years
• Bank and investment account statements
• A recent mortgage statement and proof of homeowners insurance

If you’re self-employed, plan to submit more extensive documentation of your income.

“That way, when rates drop, even if it’s just for a short time, you’re ready to lock in and move quickly,” said Dintino.

Get ready for the home appraisal (or hope for a waiver)

A home appraisal is often required so the lender can verify the current value of your home. That means sprucing up your home before the appraiser comes by so you can get the highest value possible. Think tidy landscaping, minor repairs, and a list of improvements you’ve made.

Even small updates can put your home’s value in a better light.

That said, some borrowers may qualify for an appraisal waiver, especially if they are refinancing with their current lender and have significant equity.

That can save time and money, so it’s worth asking upfront.

Pick the mortgage refinance that matches your goals

There’s no one-size-fits-all refinance for homeowners.

“Refinancing isn’t just [the mortgage] rate and [loan] term,” said Dintino. “What’s right for you depends on why you’re doing it.”

Here’s a look at the types of refinances out there:

• Rate-and-term refinance: This is the classic move. You swap in a lower rate or shorten the term of your mortgage. A 30-year loan can sometimes be converted into a 20-year or 15-year loan with only a slight increase in your monthly payment if rates come down.
• Cash-out refinance: With this option, you replace your existing mortgage with a new, larger one. This loan allows you to tap into your home equity. Then you pocket the difference and pay the loan back every month.  
• ARM to fixed-rate loans: The interest rates for adjustable-rate mortgages can reset higher if rates move up in the future. This can increase your monthly payment. (On the flip side, lower rates can equal lower payments.) Refinancing to a fixed-rate loan can buy peace of mind if you’d rather lock in a steady payment.
• Streamline refinances: Federal Housing Administration (FHA) loan and U.S. Department of Veterans Affairs (VA) loan borrowers may qualify for a simplified process that skips some documentation or even the appraisal.

Brenda Dintino NMLS # 239946