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As the economy continues to suffer from the pandemic, so many Americans are in difficult financial situations. So I thought I’d take today to talk a little bit about refinancing your home, as it could shave quite a bit off from your mortgage payment. (Very helpful right now!)
There’s no catch. It’s free money!
The mortgage situation
To kick off this post, I thought it’d be useful to discuss mortgages in general. Borrowing money to buy a house isn’t a bad thing. Mortgages enable home buyers, sellers and lenders to all get what they need. It’s the perfect little marketplace. There’s an obvious benefit for buyers and sellers, and if you look at the interest that banks charge on top of their loans, the benefits for them make total sense, too.
But banks can’t just charge whatever they want in interest. First, they must consider the risk of loaning you money. They do this by checking your employment history, credit score, income, assets and debts. And then they must consider their competition as well as other large scale factors like the state of the economy, demand for mortgages, and the interest they’re being charged by the Federal Reserve (or the Fed, if you’re nasty).
The Fed and its interest rates
The Fed is a system of giant banks set up by the government to stabilize the economy. It has a bunch of tools to achieve this goal, but arguably its most useful tool is a manipulation of the interest rate that regional banks are charged for loans. If the economy is doing great, like it was before all of this started, the Fed typically raises its benchmark interest rates to keep things from growing too quickly. If the economy is doing poorly, like it is now, the Fed can lower its interest rates to encourage more lending and economic activity throughout the system. When borrowing money is cheaper due to lower rates, regional banks have a tendency to borrow more and loan more, and if enough banks are encouraged to behave this way, the economy improves as a whole.
So the Fed is like an economic referee, nudging the marketplace in the right direction to keep the game running smoothly. And now that the economy is collapsing due to COVID-19, the Fed has taken the dramatic step of not just lowering its “Federal Funds Rate,” but cutting it down to near 0%. This means that the Fed is willing to make loans without charging interest, and it’s a move that it’s only taken in the midst of extreme economic crises.
What does today’s economy mean for your mortgage?
The Fed’s interest rate is not the same thing as a consumer mortgage rate. But historically, the Fed’s interest rates are a good indicator of where mortgage rates are headed. Simply put, now that the Fed has its interest rates at near 0%, consumer mortgage rates are expected to drop to historic lows.
“I already have a mortgage,” you might be thinking. “I pay it every month and I like it that way.”
I know. This stuff is complicated and who wants to mess with a system that took a while to set up? But I’m here to tell you is that if you’re willing to do a little bit of paper work, your mortgage payment could drop significantly. It’s truly a no-brainer!
How to refinance your mortgage
In the grand scheme of adult chores, refinancing my house was on the easier side of things. Getting Emma into pre-k, figuring out health insurance, and even returning a discolored outdoor sofa were all much more difficult tasks in my opinion. Luckily, having a mortgage means you’ve already done much of the necessary work–during that hellish experience of actually buying the home. So a refi should be a financial cake walk in comparison to what you went through before!
Step 1: Determine what you want out of your new loan
Refinancing lets you rework many of the assumptions you made at the time of your home purchase. This new loan could give you a smaller monthly payment or a shorter mortgage term… or it could even help you to consolidate other debts you have laying around. The details of your new loan are entirely up to you, and today’s low interest rates give you a lot of leverage.
My goal was to take advantage of these low interest rates to save money on my monthly payment. We bought our house less than a year ago with a 4% interest rate which, by today’s standards, is too damn high. So that’s why I did it!
Step 2: Find a lender
Refinancing a mortgage involves a new bank paying off your old mortgage, so finding that new bank is a good next step. I started my search by checking the mortgage rates at bankrate.com every few days to get a sense of the marketplace.
Refinancing does cost money. You’d better bet that every entity–from the bank to the title company to the government–is lined up in a neat little row to collect fees along the way. Luckily, many banks will reimburse most of these fees to keep the overall price of the refinance low. Remember, these banks benefit from your mortgage just as much as you do. My goal was to spend no more than $1,000 on the project in total, and I ended up spending less than $500.
It’s worth mentioning that most banks will allow you to pay additional fees or “points” up front in exchange for a lower interest rate. Ultimately I decided to pursue a “no point” loan because I expect rates to continue dropping and never saw an offer that made sense.
I pursued my refinance project with three different banks in an effort to find the best possible rate available. I let each bank know that I was doing this to give me a better negotiating position throughout the process.
Step 3: Paperwork
Your new bank needs to gain an understanding of you and your co-borrower’s whole financial situation including credit score, employment, earnings, assets, debts, dependents and all that kind of stuff. To do this, they’re going to ask for a bunch of paperwork to figure out whether you’re worth the risk of the loan.
As I mentioned before, refinancing our house wasn’t as much work as buying the house in the first place. It turns out that having an asset like a house on your application looks pretty good to the bank! Our application is more complicated than most as we’re self-employed and had to provide business records and stuff, but the basics asks were for tax returns, former employers and old residences. While the paperwork did take some time, the process was easy and worth it.
Step 4: Appraisal
Speaking of that house you’re refinancing, the bank needs to know what it’s worth. So they’re going to send someone over to appraise its value. Our appraiser, Tom, was a super nice guy. In about 15 minutes he measured the house, took note of all the improvements and went off to pull comparable homes in the area. Honestly, the appraisal was kind of fun! Though Kelly was mad that I gave her absolutely no warning and she wasn’t able to clean for him.
The appraisal price of the house gives the bank a loan-to-value ratio. Simply put, a high appraisal makes the loan-to-value ratio lower, and this makes the bank less worried about the loan. In the end, it gives you a better chance at a better interest rate.
Note: We coincidentally started refinancing before the pandemic started, so our appraisal was very safe. I do, however, understand how worrisome it would be to invite someone into your home given the current state of the world. Some banks have alternative ways to appraise your house without sending a person to do a physical walk-through, and others have strict procedures to ensure everyone’s safety. Make sure to talk this through with your bank!
Step 5: Negotiating the final rate
At this point, the bank will start the process of finalizing the loan and scheduling the closing date. This stage represents your last chance to negotiate the interest rate, so it’s worth revisiting bankrate.com and your other bank contacts to see if a better deal is out there–especially considering how volatile things are right now.
I was able to reduce my final rate by another 1/8% point with at no additional cost during this stage of the process.
Step 6: Closing
Closing on a refinance is very similar to closing on a first mortgage. There’s a big stack of paper that needs signatures and initials and dates all over the place. It’s a chore but it’s exciting to watch the stack shrink page after page until the refinance is done.
Again, I started the process before the pandemic, but our closing date was set for March, shortly after our family started self-quarantining. I took safety seriously, and closing occurred in our garage with a ton of space between the notary and me. We both wore masks and gloves, too. It probably took twice as long because of this, but it was fine. (Everything else was done online; this was the only human interaction that my bank required, and they were very accommodating and understanding of my concerns.)
I have no crystal ball and I’m certainly not a mortgage expert, but considering the present conditions of today’s market, it’s very possible that mortgage rates will continue to drop for the foreseeable future. Thirty years is a long time and, if I can, I’ll keep refinancing this house until they drag me out of the bank kicking and screaming.
Hope this was helpful! Let me know if you have any questions.