Those contemplating a refinance to lower their rates are too wary of today’s volatility. Mortgage rates are not expected to drop anytime soon but they are still considered low historically. Your refi goal to get a lower rate is clearly achievable if you consider these possible scenarios that we have laid out below.
Do It Now or Prepare for Later
Given the way mortgage rates are on an upward path, locking in a rate is the wisest move to protect yourself from further rate surges. But do this only after you’ve done enough rate searching and shopping and when you’re ready to submit your refinance application.
Even when you don’t do a rate lock, having your refi application submitted is an edge should rates drop. Your application is already in the pipeline and awaiting for consideration when something big as a rate drop happens.
Credit Score and All
If you are still not sure about your application, you can take time to work toward a successful mortgage campaign. Improve on your credit score. Your rate largely hinges on your credit score and they work in inverse. The higher your credit score, the lower your rate will be.
While credit scores improve over time, what you can do at the moment is to (a) pay your bills on time, (b) pay down your debt especially on credit cards with higher rates, and (c) refrain from taking on new credit just yet.
Consider this: When you refinance and lock your rate now, you’ll avoid further increases in the rate. When you refinance now and don’t lock in, there is a possibility of getting a higher or lower rate. To increase your chances of getting a low rate, work on improving your credit score.
Refinance into vs out of an ARM
First off, refinance from a fixed-rate mortgage to an adjustable-rate mortgage because of the latter’s lower rate. Take advantage of the low teaser rates at the onset of the loan because it means bigger savings. Contemplate a FRM-to-ARM refinance if you plan to stay less than the loan term or before the rate adjusts as in the case of 5/1 adjustable-rate mortgages.
The risk of a higher rate when the ARM rate adjusts is something you can avoid when you refinance out of it and into an FRM. But the catch is you’re going to pay for a higher rate with a fixed-rate mortgage.
Another adjustable-rate mortgage that you’d want to consider to refinance out of is a home equity line of credit. Like any ARM, it starts with a lower rate but after its draw period expires and the repayment period comes in, you have to pay the interest + principal portion of the loan. Your monthly HELOC payments would then increase.
The volatility of ARMs is partly due to their rates being tied to the federal funds rate, which is expected to rise anytime soon.
Consider this: When you refinance from an ARM to an FRM, expect your rate to increase and make higher but stable monthly payments.
Refinance to a Shorter-Term Loan for Long-Term Purposes
Refinancing into a 15-year fixed-rate mortgage from a 30-year fixed-rate mortgage lowers your rate (15-year FRMs having lower rates than 30-year FRMs).
The 15-year mortgage has a higher monthly payment than the 30-year which makes it faster to pay off the principal portion of the loan. In the long run, this saves you on the interest cost of the mortgage.
Consider this: When refinancing to a shorter-term loan, expect your monthly payment to increase and pay off your mortgage faster.
Points for Paying Points
Another way to lower your rate by, say 0.25%, is to buy discount points. A discount point is equal to 1% of your loan amount. Purchasing discount points point to two major considerations: the length of your stay and the availability of funds to pay for them.
Consider this: To maximize your savings out of buying the discount points, stay longer in the house.
Justin McHood is a managing partner at Suited Connector and has been recognized by national media outlets as a financial expert for more than a decade.
