With the avg values of US homes up about 20% this last year and historically low interest rates in the low 3’s. If you’re not interested in selling your current home. Then to refi or not to refi, is likely the question you’re thinking of. Even if you’re a relatively new homeowner of 2-3 years, doing a refi now could potentially remove your PMI early without having to actually pay 20% of your original purchase price down. So how do you know if a refinance is right for you? Well, there are a lot of variables that go into a refinance and everyone’s personal and financial situation is different. Here are some of the major items you should consider to help you decide, to refi or not to refi.
- Check to make sure your home has enough equity. If there’s not enough equity, you won’t be able to refinance, so start here. Typically lenders will only give you a loan for up to 80% of your homes current worth, meaning you need to have at least 20% equity available. Equity is the difference between your current mortgage balance (all of them if you have multiple mortgages) and what your home is currently worth in today’s market. To get an estimate of your current home’s worth, reach out to a real estate agent and ask them if they can run a CMA (comparable market analysis) on your home because you’re thinking of refinancing. It is important to know that a CMA value is not an absolute value that the lender will use. The lender will require an independent appraisal. Now you will know roughly what your home is worth in the current market and deduct this from your current mortgage(s) balance. The result is your current available equity in dollars. To figure out the equity as a %, take your equity in dollars and divide by the estimated worth of the home and multiply by 100 to get the %.
Example: Current mortgage balance $125,000
CMA home value estimate in current market: $195,000
Home Equity Available: $195,000 – $125,000 = $70,000 Equity
Equity %: $70,000 / $195,000 = 36% Equity available
Current Debt %: 100% – 36 % = 64% Debt
Current LTV Ratio = 64% Loan / 36% Equity
Max LTV = 80% / 20%
Because the borrower has a LTV less than 80/20, the borrower has 2 options available:
1. Refinance only the current balance owed, which will reduce their mortgage payments.
2. Refinance up to 80% of the home’s worth, allowing them to borrow money from their home at the new lower rate, tax free. In this example:
New Loan at 80/20 LTV = $195,000 X 0.8 = $156,000
Max Amount of Money able to Borrow: $156,000 – $125,000 = $31,000
- So of the $70,000 equity available in the home, the borrower could only take out a max of $31,000 because they have to maintain a LTV of 80% / 20%. The money taken out could be used to do whatever the borrow wants whether that be, buy a car, payoff other debt, remodel the home, invest, or buy another home possibly. Depending on how big of a difference between the borrower’s current rate and their new rate, even after taking out the extra money, the borrower’s new mortgage payments can still be less or equal to what they’d be currently paying every month.
- Check your credit score. To get the best rates below 3% or slightly above 3%, you will need a credit score of 760+. Check your credit score for free at www.annualcreditreport.com. However, even if you don’t have that high of a credit score, your new rate may still be lower than your current rate. The rule of thumb is that your new interest rate should be at least 1% lower than your current rate for the refinance to make sense.
- Check your debt to income ratio or DTI. Just like when buying a home, lenders want to check that your current DTI can support the new payments from the refinance loan. This is especially important if you have acquired a lot of equity in your home and want to take out additional funds on top of what your current mortgage balance is. Ideally, lenders want to make sure your housing payments are about 30% or less of your gross monthly income and that your overall DTI is less than 40%. Each lender has different requirements and lending guidelines. To determine DTI, add up your monthly debts and divide by your total gross income.
- Closing costs and fees. Refinancing your loan will require paying closing costs again and this can be anywhere from 2-5% of your loan amount. Make sure you have the funds to cover closing costs. But more importantly make sure that you plan to stay in that home long enough to break even or recoup those closing costs. To figure this out, take your estimated closing cost and divide by the monthly mortgage savings amount. This will tell you how many months it will take for you to recover the cost of the refinance.
Example: $200,000 Refinance
Estimated Closing Cost at 3%: $200,000 X 0.03 = $6,000 Closing Cost
Estimated Monthly Mortgage Savings $200/mo: $6,000 / $200 = 30 months required to break even with closing costs.
You may also see lenders offer refinances with no closing costs or fees for things like appraisal, but nothing is free. Check carefully because they might just roll those closing costs into your loan or they give you just slightly higher interest rate to cover those closing costs. Ask questions and make sure you understand all the fees and terms. - How’s the condition of your home? Because the lender will most likely require an appraiser to visit and walk through your home. Your home needs to at least be in good shape, meaning clean, tidy, and decent curb appeal. It doesn’t necessarily need to be updated/completely remodeled, but if you have done any of those or installed new major mechanicals it is beneficial to let the lender and appraiser know. There should be no major visible defects such as a hole in the roof, walls, or major foundation cracks. Even minor details such as excessive chipped paint, broken windows, flooring defects, paint touch up interior walls should be addressed in preparation for the appraisal. You’ll definitely want to make sure your home is ready for an appraisal before applying for a refinance as the appraisal can happen quickly after the application is submitted. Taking the time to make your home look as nice as it can without too much money or effort will help increase the chances of getting a higher home appraisal value.
Hopefully, these tips help you to make your decision whether it makes sense for you to refinance or not. If it’s the right decision for you, you should hurry. Rates are rising and this may be the last time to get in at the historically low rates. On the other hand, you may find after further consideration, your situation has changed, you may be wanting to move, need a bigger or smaller home, and it’s not worth paying a refinance closing cost. Instead, it may make more sense to sell now to take advantage of the high home appreciation and still historically low interest rates to get a home you would much rather prefer to be in. As always, if you should need help with your real estate needs in the greater Milwaukee area, contact me!