How soon one can refinance a mortgage after buying a home is a common question among homeowners. While refinance affords a good opportunity to save thanks to a lower rate, costs and fees are to be factored in. What do you wish to achieve when you refinance?
Is your goal to: (i) lower your rate and lower your monthly payments, (ii) switch to a less risky loan type or (iii) pay off your loan faster? Now let’s see how well your goal fits into the following considerations.
How Soon Should You Refinance Your Mortgage?
With your mortgage fairly fresh from origination, these things are a top-notch consideration:
- Seasoning Requirement
- Prepayment Penalty
- Closing Costs
- Break-even Point
Seasoning and Equity
Generally speaking, lenders prefer that the mortgage has been with you for at least a year before any refinance happens. This seasoning requirement protects them from any property flipping and frequent cash-out refinancing that depletes the equity of the home.
You don’t have much equity in your home at its inception, either. This holds true for loans with less than 20% down payment and a longer repayment period. It is the interest portion of the loan that gets paid out early on in its life.
Each loan program has its seasoning requirements, as follows:
- Conventional loans. There is no “waiting period” so to speak to refinance but a cash-out refinance calls for stricter rules. Cash-out refinances on conventional loans require a seasoning period of six months and the loan-to-value ratio must be 70%.
- FHA loans. For streamline refinance loans, the required period is six months.
- VA loans. Six months is the seasoning requirement for the Interest Rate Reduction Refinance Loan, VA’s streamline refinance program.
Prepayment Equals Refinance
When you refinance your loan, you are basically paying it off, something a prepayment penalty keeps in check. It is a fee that serves to deter homeowners from paying off their loan at its early stage.
Prepayment penalties are structured differently among lenders. One lender, for example, limits how much the borrower can pay down the principal to 20% a year. If the borrower decides to refinance, he/she will have to pay a penalty fee equivalent to 80% of the interest-portion of the mortgage for six months.
Closing Costs Anew
Whether it is for a purchase or refinance loan, expect to incur fees when taking out one. While these costs can be wrapped into the loan, the result is often a higher loan amount or a higher interest rate.
From origination costs to credit report fees, closing costs are wedged between 2% and 5% of your loan amount. Are you willing to pay another set of fees in refinancing after buying a home too soon?
Breakeven Point vs Length of Stay
Closing costs plus prepayment penalties and more are taken into account by a breakeven point. Put simply, it measures how long it takes for you to recover the costs of refinancing.
It takes at least two years for your savings in getting the refi loan to offset the costs you paid to get it. The breakeven point easily varies among homeowners.
To calculate the break-even point:
- Calculate your expected savings every month and subtract it from your current monthly payment.
- Sum up all costs, fees and penalties incurred in opening and closing the refi loan.
- Divide the total costs over the monthly savings.
Compare your breakeven point with your plan to stay in the home. Which is more beneficial for you: to stay longer or move out?
These are just some factors to consider the timing for a refinance after buying a home. Ask your lender if there are rules you should know about.
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.