The first piece of information that you will need to review is to work out how much equity is in your home. If your house is now worth less than it was when you began your mortgage—known as being in negative equity—then it doesn’t make sense to refinance your mortgage.
At the end of the second quarter of 2021, consumer confidence had risen to its highest level since the beginning of the COVID-19 pandemic. This means that, according to property information provider CoreLogic, many homeowners have seen large increases in their equity. A recent report shows that U.S. homeowners with mortgages (which account for roughly 63% of all properties) have seen their equity increase by 29.3% year over year (YOY), representing a collective equity gain of more than $2.9 trillion, and an average gain of $51,500 per borrower, since the second quarter of 2022.1
This means that the number of homeowners in negative equity has decreased significantly in the last year. In the second quarter of 2020, 1.8 million homes—or 3.3% of all mortgaged properties—were in negative equity. This number decreased by 30%, or 520,000 properties, in the second quarter of 2021.1
Still, some homes have not regained their value, and some homeowners have low equity. Refinancing with little or no equity is not always possible with conventional lenders. However, some government programs are available. The best way to find out if you qualify for a particular program is to visit a lender and discuss your individual needs. Homeowners with at least 20% equity will have an easier time qualifying for a new loan.2
Lenders have tightened their standards for loan approvals in recent years. Some consumers may be surprised that even with very good credit, they will not always qualify for the lowest interest rates. Typically, lenders want to see a credit score of 760 or higher to qualify for the lowest mortgage interest rates. Borrowers with lower scores may still obtain a new loan, but they may pay higher interest rates or fees.
KEY TAKEAWAYS
If you already have a mortgage loan, you may assume that you can easily get a new one. However, lenders have not only raised the bar for credit scores but also become stricter with debt-to-income (DTI) ratios. While some factors—such as having a high income, a long and stable job history, or substantial savings—may help you qualify for a loan, lenders usually want to keep the monthly housing payments under a maximum of 28% of your gross monthly income.
Overall, your DTI ratio should be 36% or less, although with some additional positive factors, some lenders will go up to 43%. To qualify, you may want to pay off some debt before refinancing.
Refinancing a home usually costs 3% to 6% of the total loan amount, but borrowers can find several ways to reduce the costs (or wrap them into the loan). If you have enough equity, you can roll the costs into your new loan (and thus increase the principal). Some lenders offer a “no-cost” refinance, which usually means that you will pay a slightly higher interest rate to cover the closing costs. Don’t forget to negotiate and shop around, because some refinancing fees can be paid by the lender or even reduced.
While many borrowers focus on the interest rate, it’s important to establish your goals when refinancing to determine which mortgage product meets your needs. If your goal is to reduce your monthly payments as much as possible, you will want a loan with the lowest interest rate for the longest term.
If you want to pay less interest over the length of the loan, look for the lowest interest rate at the shortest term. Borrowers who want to pay off their loan as fast as possible should look for a mortgage with the shortest term that requires payments that they can afford.
When you compare various mortgage loan offers, make sure that you look at both the interest rates and the points. Points—equal to 1% of the loan amount—are often paid to bring down the interest rate. Be sure to calculate how much you will pay in points with each loan, as these will be paid at the closing or wrapped into the principal of your new loan.
Lenders have tightened their standards for loan approvals in recent years, requiring higher credit scores for the best interest rates and lower DTI ratios than in the past.
An important calculation in the decision to refinance is the breakeven point: the point at which the costs of refinancing have been covered by your monthly savings. After that point, your monthly savings are completely yours. For example, if your refinance costs you $2,000 and you are saving $100 per month over your previous loan, it will take 20 months to recoup your costs. If you intend to move or sell your home within two years, then a refinance under this scenario may not make sense.
Homeowners who have less than 20% equity in their home when they refinance will be required to pay private mortgage insurance (PMI). If you are already paying PMI under your current loan, this will not make a big difference to you. However, some homeowners whose homes have decreased in value since the purchase date may discover that they will have to pay PMI for the first time if they refinance their mortgage.
The reduced payments due to a refinance may not be low enough to offset the additional cost of PMI. A lender can quickly calculate whether you will need to pay PMI and how much it will add to your housing payments.
Many consumers have relied on their mortgage interest deduction to reduce their federal income tax bill. If you refinance and begin paying less in interest, then your tax deduction may be lower. (It’s important to keep in mind that few people view that as a good-enough reason to avoid refinancing.)
However, it is also possible that the interest deduction will be higher for the first few years of the loan (when the interest portion of the monthly payment is greater than the principal). Increasing the size of your loan, as a result of taking out cash or rolling in closing costs, will also affect how much interest you will pay.
Mortgage lending discrimination is illegal. If you think you’ve been discriminated against based on race, religion, sex, marital status, use of public assistance, national origin, disability, or age, there are steps that you can take. One such step is to file a report with the Consumer Financial Protection Bureau (CFPB) or the U.S. Department of Housing and Urban Development (HUD).
That said, provisions of the Tax Cuts and Jobs Act (TCJA), passed into law in December 2017, may affect your desire to use the mortgage interest deduction.3 The new higher standard deduction—$25,100 for married couples filing jointly in 2021, compared with $12,700 under the previous law—may make itemizing deductions less financially attractive to more taxpayers.4
Wealthier homeowners who want to refinance a large existing mortgage will still be able to deduct interest on up to $1 million in mortgage debt, but the limit for new mortgage debt is now $750,000 for homes bought on Dec. 15, 2017, or later. Given these changes, it’s wise to consult a tax advisor for individual information on the impact of refinancing on your taxes.
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