Understanding Your Home Refinancing Options

Garret Spiecker, Managing Director, First Republic Bank
January 23, 2018

Mortgage interest rates have been hovering near historic lows for nearly a decade, but that doesn’t mean you should rule out refinancing your home. While every situation is different, there are circumstances when it makes sense to refi, even if rates have not dropped significantly.

Some key reasons to rethink your mortgage include: using a cash-out refinance to fund a major remodel, trading in an adjustable-rate mortgage (ARM) for a fixed-rate mortgage, refinancing out of private mortgage insurance or simply getting a better interest rate.

If you're considering refinancing your mortgage, here are the major things you need to know:

Understanding the basics

Before you look seriously into refinancing, you’ll want to get an idea of how much your home is worth. Although home prices in most markets have been steadily appreciating, it’s better to know exactly what you’re up against before you start the process. Zillow and Trulia estimates can give you a ballpark, but looking at actual sale prices for comparable homes in your neighborhood is an even better gauge. It may even be worth checking with the real estate agent who helped you buy the home to see where they would recommend listing the house at today.

It’s also a good idea to consider your current financial situation. How is your credit? Has your household income changed? What about your overall debt and savings? If you are in better shape than you were when you got your original mortgage, it’s probably safe to assume that you won’t have trouble refinancing. If your creditworthiness has deteriorated, however, you’ll want to factor this into your decision.

Refinancing, after all, takes time — you’ll need to prepare all the same documents you did for your purchase mortgage. There are also fees associated with a refinance. Some lenders may offer a no-cost refinance, but be wary of the fees baked into the interest rate. 

Some lenders previously offered existing customers a streamlined refinance, but this is less common today than it was in the past. You should start your search for a new mortgage with your existing lender, as they may be able to help you with a modification. However, it’s always a good idea to shop around — and borrowers may be able to save money by working directly with a lender.

Reasons to consider a refi

If you’re thinking about refinancing simply to get a slightly lower rate, you’ll want to do the math and calculate how long it will take to break even. That is, how much will you save each month and how long will it take you to recoup the fees you pay to refinance? For example, if you pay $3,500 monthly for your mortgage and can bring that cost down to $3,250 by refinancing, it will take you 12 months to recoup $3,000 in total refinancing costs. Get a customized estimate based on your current costs by using a basic mortgage calculator.

As a rule of thumb, if you can save between 0.4 and 0.5 percentage points on your interest rate, a refinance is worth pursuing, as it will typically take less than a year and a half to break even.

While reducing your monthly payment is one of the biggest reasons you should consider refinancing, there are situations where it might make sense to refinance even if rates haven’t come down much. For example:

Cash-out refi: On average, home prices have appreciated since the financial crisis, giving homeowners in many markets significant equity. Pulling equity out of a house is a decision that should not be taken lightly, but there are cases where it can be a prudent move, such as for financing a major renovation.

Depending on the size of your project, a home equity line of credit (HELOC) may be a better option. This allows you to leave your first mortgage in place and take out a line of credit against the equity in your home. Rates for lines of credit recently hovered around 5.3 percent. One thing to keep in mind, however, is that HELOC rates are typically adjustable.

Trading in an ARM: It’s not uncommon for first-time homebuyers to go with an ARM, the logic being that they might only be in the house for five or seven years. If this was your logic behind taking out an ARM and you now anticipate staying in the house longer, it might be time to lock in a low fixed rate and avoid the potential of seeing your payments go up. If you have a 4 percent adjustable-rate on a $600,000 loan, for example, a 1 percentage point increase could add more than $350 to your monthly payment.

Dropping PMI: When borrowers finance a house with less than 20 percent down, they are typically required to have private mortgage insurance (PMI), which can add anywhere from 0.3 to 1.5 percent of the original loan amount to annual mortgage costs. Owners can automatically cancel PMI when they’ve paid enough principal to get their loan-to-value ratio down to 80 percent, but that is typically based on the original home value. If your house has since appreciated significantly, refinancing is one way to drop PMI quickly, and potentially qualify for a lower rate in the process. (Before you refinance, see if your lender will cancel PMI based on a new appraisal.)

Take note: When you hit the restart on a mortgage, you turn back the amortization clock, which means that most of your initial payments will go toward interest. As time goes on, an increasing share of your payment goes toward your principal.

Before you refinance, for any reason, it’s important to step back and take a look at the big picture. While there are many situations when refinancing can add up to serious savings over the long run, don’t rush into a refi without thinking through whether it adds up for your unique situation. 

The strategies mentioned in this article will often have tax and legal consequences; therefore, it is important to bear in mind that First Republic does not provide tax or legal advice. This information is provided to you as is, does not constitute legal advice, is governed by our Terms and Conditions of Use, does not necessarily reflect the views of First Republic Bank, and we are not acting as your attorney. We make no claims, promises or guarantees about the accuracy, completeness, or adequacy of the information contained here. Clients’ tax and legal affairs are their own responsibility. Clients should consult their own attorneys or other tax advisors in order to understand the tax and legal consequences of any strategies mentioned in this article.

© 2018 First Republic Bank