Refi Rules

If you’re considering refinancing your mortgage, you may have searched for the “refinance rule of thumb” to help you make your decision.
Of course, there isn’t a single refinance rule of thumb. One popular one is that you should only refinance if your new interest rate will be two percentage points lower than your current mortgage rate.
Only Refinance If the New Mortgage Rate is 2% Lower
For example, if your current mortgage rate is 6%, that rule would tell you refinance only if you could snag a rate of 4% or lower.
But clearly this rule is much too broad, just like any other rule out there. When it comes down to it, a refinance decision will be unique to you and your situation, not anyone else’s.

This old rule assumes most mortgage amounts are pretty small, unlike the jumbo loans we see nowadays.
Let’s take a look at some math to illustrate why this refinance rule falls short:
Loan amount: $500,000
Loan type: 30-year fixed-rate mortgage
Current mortgage rate: 5%
Refinance mortgage rate: 4%
Cost to refinance: $4000
In this scenario, the existing mortgage payment is $2,684.11. If refinanced to 5%, the monthly mortgage payment falls to $2,387.08. That’s a difference of nearly $300 a month, which will certainly make it easier to meet your mortgage obligation.
However, it will take 13 months to recoup the cost of the refinance ($4000/$297).
That said, the refinance “breakeven period” (time to recoup your costs) is very short here. So we don’t need to follow that “2% lower rate” refinance rule.
But what if the loan amount is only $100,000? The game changes in a hurry. Your mortgage payment would drop from $536.82 to $477.42. That’s roughly $60 in monthly savings, not very significant.
Assuming the cost of the mortgage was still somewhere around $3,000, it would take 50 months, or more than four years, to recoup the costs associated with the refinance.
So if you were thinking about selling your home in the short term, it probably wouldn’t make sense to throw money toward a refinance.
This is probably why this old refinance rule exists. But home prices are higher these days, so it’s not a good rule to follow for everyone.

Only Refinance If You’ll Save “X” Dollars Each Month
Another common refinance rule of thumb says only to refinance if you plan to live in your home for “X” amount of years, or only to refinance if you’ll save “X” dollars each month.

Again, as seen in our example above, you can’t just rely on a blanket rule to determine if refinancing is a good idea or not.
Some borrowers may need to stay in their home for five years to save money, while others may only need to stick around for just over a year.
But plans change, and you may find yourself living in your home much longer (or shorter) than anticipated.
And if you look at the refinance savings in dollar amounts, it will really depend on the cost of the refinance and how long you make the new payment.
If it’s a no cost refinance, you won’t even have to worry about the break-even period.
So it’d be foolish to get caught up on this rule unless you have a bulletproof plan.

Consider the Mortgage Term
Finally, consider the mortgage term when refinancing, and the total amount of interest you can avoid paying over the life of the loan.
If you’re currently five years into a 30-year fixed mortgage, and refinance into a 15-year fixed mortgage, you’ll shave 10 years off your mortgage term.
Assuming mortgage rates are lower at the time of refinance, you’ll save both in monthly payment and in total interest paid, which will shorten your break-even period and maximize your savings.
Also factor in your current loan type versus what you plan to refinance into. If you’re currently holding an adjustable-rate mortgage that will reset higher soon, the decision to refinance may be even more compelling.
At the end of the day, you shouldn’t use any general rule to determine whether or not you should refinance.
Doing so is lazy, especially when it’s not that hard to run a few numbers to see what will make sense for you.
If you feel overwhelmed by all the math, ask a loan officer or mortgage broker to run some scenarios for you to illustrate the potential savings and break-even periods.
And take your time – you’re not shopping for a big screen TV, you’re making one of the biggest financial decisions of your life.

FHA vs Conventional

Our latest mortgage match-up pits FHA loans against conventional loans, both of which are popular options for homeowners these days.
In recent years, FHA loans have surged in popularity, largely because subprime lending (and Alt-A) was all but extinguished as a result of the ongoing mortgage crisis.
Some even claim FHA loans are the “new subprime,” mainly because of the low down payment and credit score requirements, despite originally being designed for low and moderate-income borrowers.
But you don’t have to be a subprime borrower to take advantage of an FHA loan.
FHA Loans Are a Great Low Down Payment Option
As noted, these government-backed home loans have become insanely popular. The main selling point of an FHA loan is the 3.5% minimum down payment requirement.
However, in order to qualify for the flagship low down payment option, you need a minimum credit score of 580.
And 580 is just the FHA’s guideline – individual banks and mortgage lenders still need to agree to offer such loans.
So there’s a decent chance you’ll need an even higher credit score. Of course, a 580 credit score is pretty dismal…

FHA Loans Good for Those with Poor Credit
The other major selling point to an FHA loan is that the minimum credit score is 500. Again, this is subject to lenders actually offering programs for scores this low. And scores between 500 and 579 require a minimum down payment of 10%.
But FHA loans can be a good option for those with poor credit who are determined to get a mortgage.
Another benefit to going with an FHA loan is the higher loan limit, which is as high as $729,750. This can be a real lifesaver for those living in high-cost regions of the country.
Meanwhile, conventional conforming loans backed by Fannie Mae and Freddie Mac are capped at $625,500. Anything above that is considered a jumbo loan, and will come with a higher mortgage rate.
FHA Loans Subject to Mortgage Insurance
We’ve talked about some benefits of FHA loans, but there are drawbacks as well.
The major one is the mortgage insurance requirement. Those who opt for FHA loans are subject to both upfront and annual mortgage insurance premiums.
The upfront mortgage insurance requirement is unavoidable, and the annual premium can only be avoided if you have 22 percent or more home equity and a loan term of 15 years or less.
All other borrowers must pay the annual mortgage insurance premium for a minimum of five years, which will clearly increase the cost of the mortgage.
[Note that FHA insurance premiums are also slated to increase!]
Keep in mind that FHA loan offerings are pretty basic. They offer both purchase money mortgages and refinance loans, but the choices are slim.

How are Mortgage Rates Determined?

How Are Mortgage Rates Determined?
One of the most important aspects to successfully obtaining a mortgage is getting the best interest rate. For most homeowners, this means securing the lowest, fixed interest rate (no negative amortization!).
Many homeowners rely on their bank or mortgage broker to secure their interest rate, often without researching mortgage lender rates or inquiring about how they move. Whether you’re interested in rates or not, it’s wise to get a better understanding of how mortgage rates move, and why.
After all, a change in rate of a mere .125% to .25% could mean thousands of dollars in savings each year.
So how are mortgage rates determined?
Although there are a slew of different factors that affect interest rates, the movement of the 10-year Treasury bond yield is said to be the best indicator to determine whether mortgage rates will rise or fall. But why?
Though most mortgages are packaged as 30-year products, the average mortgage is paid off or refinanced within 10 years, so the 10-year bond is a great bellwether to measure interest rate change. Treasuries are also backed by the “full faith and credit” of the United States, making them the benchmark for many other bonds as well.
Additionally, 10-year Treasury bonds, also known as Intermediate Term Bonds, and long-term fixed mortgages, which are packaged into mortgage-backed securities (MBS), compete for the same investors because they are very similar financial instruments.
However, treasuries are 100% guaranteed to be paid back, while mortgage-backed securities are not, for reasons such as payment default and early repayment, and thus carry more risk and must be priced higher to compensate.
How will I know if mortgage rates are going up or down?
Typically, when bond rates (also known as the bond yield) go up, interest rates go up as well. And vice versa. Don’t confuse this with bond prices, which have an inverse relationship with interest rates.
How Are Mortgage Rates Determined?
One of the most important aspects to successfully obtaining a mortgage is getting the best interest rate. For most homeowners, this means securing the lowest, fixed interest rate (no negative amortization!).
Many homeowners rely on their bank or mortgage broker to secure their interest rate, often without researching mortgage lender rates or inquiring about how they move. Whether you’re interested in rates or not, it’s wise to get a better understanding of how mortgage rates move, and why.
After all, a change in rate of a mere .125% to .25% could mean thousands of dollars in savings each year.
So how are mortgage rates determined?
Although there are a slew of different factors that affect interest rates, the movement of the 10-year Treasury bond yield is said to be the best indicator to determine whether mortgage rates will rise or fall. But why?
Though most mortgages are packaged as 30-year products, the average mortgage is paid off or refinanced within 10 years, so the 10-year bond is a great bellwether to measure interest rate change. Treasuries are also backed by the “full faith and credit” of the United States, making them the benchmark for many other bonds as well.
Additionally, 10-year Treasury bonds, also known as Intermediate Term Bonds, and long-term fixed mortgages, which are packaged into mortgage-backed securities (MBS), compete for the same investors because they are very similar financial instruments.
However, treasuries are 100% guaranteed to be paid back, while mortgage-backed securities are not, for reasons such as payment default and early repayment, and thus carry more risk and must be priced higher to compensate.
How will I know if mortgage rates are going up or down?
Typically, when bond rates (also known as the bond yield) go up, interest rates go up as well. And vice versa. Don’t confuse this with bond prices, which have an inverse relationship with interest rates.
10-year bond yield up, mortgage rates up.
10-year bond yield down, mortgage rates down.
To get an idea of where mortgage rates will be, bond investors typically use a spread of about 170 basis points, or 1.70% above the 10-year bond yield to estimate interest rates. So a bond yield of 4.00% plus the 170 basis points would put mortgage rates around 5.70%. Of course, this spread can vary over time, and is really just a quick way to ballpark mortgage interest rates.
There have been, and will be periods of time when mortgage rates rise faster than the bond yield, and vice versa. So just because the 10-year bond yield rises 20 basis points doesn’t mean mortgage-backed securities will do the same. In fact, MBS could rise 25 basis points, or just 10 points, depending on other market factors.
What other factors move mortgage rates?
Factors such as supply come to mind. If loan originations skyrocket in a given period of time, the supply of mortgage-backed securities will rise beyond the demand, and prices will need to drop to become attractive to buyers.
Timing is also an issue. Though bond prices may plummet in the morning, and then rise by the afternoon, mortgage rates may remain unchanged. That’s because sometimes the bond movement doesn’t always make it down to the wholesale markets, or simply because it takes more time to do so.
Inflation also greatly impacts mortgage rates. If inflation fears are strong, interest rates will rise, but in times when there is little risk of inflation, mortgage rates will most likely fall.
Economic activity impacts mortgage rates.
Mortgage rates are more susceptible to economic activity than treasuries, mainly because the average consumer or homeowner may lose their job or be unable to make their mortgage payment, while the US government typically doesn’t miss payments.
For this reason, jobs reports, Consumer Price Index, Gross Domestic Product, Home Sales, Consumer Confidence, and other data on the economic calendar can move mortgage rates significantly.
And don’t forget the Fed. When they release “Fed Minutes” or change the Federal Funds Rate, mortgage rates can swing up or down depending on what their report indicates about the economy. Generally, a growing economy leads to higher mortgage rates and a slowing economy leads to lower mortgage rates.
As a rule of thumb, bad economic news brings on lower rates, and good economic news makes mortgage rates climb.
The situation is a lot more complicated, so consider this is an introductory lesson on a very complex subject. And remember, the par mortgage rates you see advertised don’t take into account any pricing adjustments or fees that could drive your actual interest up or down considerably.

Arms, Not a Good Idea

With mortgage rates as low as they are at the moment, you may be looking beyond fixed-rate options if you’re in the market to purchase a home or refinance your existing loan.
After all, while 30-year fixed mortgage rates are hovering around 4%, some 5/1 adjustable-rate mortgages are in the 2% range. This can certainly push your monthly mortgage payment lower.
And the interest rate on a 5/1 ARM is fixed for the first five years before becoming annually adjustable, so there’s relative safety there if you don’t plan on sticking around for long.
Let’s look at a quick example to illustrate:
30-year fixed @ 4%: $1432.25
5/1 ARM @ 2.75%: $1224.72
On a $300,000 loan amount, the difference in monthly mortgage payment is roughly $200 a month. Over five years, that’s $12,000.
Not an incidental amount by any stretch, but there has to be a catch, right?

Well, we’re in a unique spot at the moment. Mortgage rates are pretty much in unprecedented territory.
They’re not rock-bottom, as they’ve risen in the past few weeks, but they’re still at lows not seen pretty much ever in our lifetimes.
Mortgage Rates Have Nowhere To Go But Up
Unfortunately, the general consensus is that mortgage rates have nowhere to go but up. That’s pretty much not debatable, but the big question is when?
They could rise quite quickly if the economy gets back on track, which is a must eventually, right?
So if you reside in a home that you plan on living in for the foreseeable future, gambling on an ARM right now may burn you in the future.
Sure, you may save money over the next 5+ years, but after that, you may find that mortgage rates have surged.
At that point, when your ARM is set for its first adjustment, it will adjust higher. And potentially a lot higher.
Don’t Choose an ARM If You Can’t Handle the Higher Payment
If you can’t handle that interest rate uncertainty, and don’t know if you’ll be selling before the adjustable period ends, an ARM isn’t a good choice right now.
Once interest rates rise, you’ll be stuck with a larger payment, or forced to refinance to stop the bleeding.
And even refinancing may be out of the question if you’ve got income restraints (debt-to-income ratio).
Think of it this way. At the moment, affordability is a lot higher because interest rates are really low and home prices have fallen from their highs.
In the future, assuming both home prices and interest rates rise, you may not qualify for a new mortgage. So you’ll be stuck with what you’ve got.
Would you rather be stuck in an ARM that’s constantly rising, or a fixed mortgage in the low 4% range?

What is a Lender credit?

Mortgage Q&A: “What is a lender credit?”
Back before the mortgage crisis reared its ugly head, it was quite common for loan officers and mortgage brokers to get paid twice for originating a single loan.
They could charge the borrower directly, via mortgage points, while also receiving compensation from the issuing mortgage lender, via yield spread premium.
Clearly this didn’t sit well with regulators, so in light of this perceived injustice to borrowers, changes were made that essentially limited a loan originator to getting just one form of compensation.
Borrower or Lender Compensation?
Now loan originators must choose between borrower or lender compensation, with many opting for lender compensation as a means to keep a borrower’s out-of-pocket costs low.
With lender paid compensation, a lender essentially provides a loan originator with “X” percent of the loan amount as commission.
So a mortgage broker may receive 2% of the loan amount from the lender for funding the loan. However, in doing so, they are sticking the borrower with a higher mortgage rate. This is the tradeoff.
In other words, a mortgage with lender-paid compensation will come with a higher-than-market interest rate, all other things being equal.
Quick example of a lender credit:
Loan type: 30-year fixed
Par rate: 3.5%
Offered rate: 4%
As you can see, in this scenario the borrower actually qualifies for a par mortgage rate of 3.5%. However, they are offered a rate of 4%, which allows the loan originator to get paid for handling the loan.
The loan originator’s lender-paid compensation may have pushed the interest rate to 3.75%, but there are still closing costs to consider. They may bump the interest rate up to 4%, using a “lender credit,” to cover those costs so the borrower can refinance for “free.” This is known as a no closing cost loan.
In other words, the loan originator increases the interest rate twice. Once for their commission, and a second time to cover closing costs.
On the Good Faith Estimate, you should see a line detailing the lender credit that says, “this credit reduces your settlement charges.” It’s a shame it doesn’t also say that it “increases your rate.” But what can you do…
The obvious benefit is avoiding out-of-pocket expenses, which is important if a borrower doesn’t have a lot of extra cash on hand, or simply doesn’t want to spend it on refinancing their mortgage.
It also makes sense if the interest rate is pretty similar to one where the borrower must pay both the closing costs and commission.
For instance, there may be a situation where the mortgage rate is 3.5% with the borrower paying all the closing costs and commission, as opposed to 3.75% with all fees paid and the borrower receiving a lender credit.
That’s a relatively small difference in rate, and the upfront closing costs for taking on the slightly lower rate wouldn’t be recouped for years.
In the case of borrower paid compensation, the borrower pays all closing costs as well as the loan originator’s commission.
The benefit here is that the borrower can secure the lowest possible interest rate, but it means they must pay out-of-pocket to obtain it.
They can still offset some of the out-of-pocket expense with a lender credit, but that will come with a higher interest rate, so it’s somewhat counter-intuitive. And the credit can’t be used to cover loan originator compensation. But do the math to see if it’ll save you some money over lender-paid compensation.
Which is the Better Deal?
Generally, if you plan to stay in the home (and with the mortgage) for a long period of time, it’s okay to pay for a lower rate. You could save a ton in interest long-term.
But if you plan to move or refinance in a relatively short period of time, a loan with a lender credit may be the best deal.
You won’t have to pay much (if anything) for taking out the loan, and you’ll only be stuck with a slightly higher mortgage payment.
As always, be sure to compare both options to determine which is the best deal (yes, you need a calculator).
There will be cases when a loan with the lender credit is the better deal, and vice versa. So shop around! You should be able to find a competitive rate with a lender credit.

FHA vs Conventional

Our latest mortgage match-up pits FHA loans against conventional loans, both of which are popular options for homeowners these days.
In recent years, FHA loans have surged in popularity, largely because subprime lending (and Alt-A) was all but extinguished as a result of the ongoing mortgage crisis.
Some even claim FHA loans are the “new subprime,” mainly because of the low down payment and credit score requirements, despite originally being designed for low and moderate-income borrowers.
But you don’t have to be a subprime borrower to take advantage of an FHA loan.
FHA Loans Are a Great Low Down Payment Option
As noted, these government-backed home loans have become insanely popular. The main selling point of an FHA loan is the 3.5% minimum down payment requirement.
However, in order to qualify for the flagship low down payment option, you need a minimum credit score of 580.
And 580 is just the FHA’s guideline – individual banks and mortgage lenders still need to agree to offer such loans.
So there’s a decent chance you’ll need an even higher credit score. Of course, a 580 credit score is pretty dismal…
[How to get a mortgage with a low credit score.]
FHA Loans Good for Those with Poor Credit
The other major selling point to an FHA loan is that the minimum credit score is 500. Again, this is subject to lenders actually offering programs for scores this low. And scores between 500 and 579 require a minimum down payment of 10%.
But FHA loans can be a good option for those with poor credit who are determined to get a mortgage.
Another benefit to going with an FHA loan is the higher loan limit, which is as high as $729,750. This can be a real lifesaver for those living in high-cost regions of the country.
Meanwhile, conventional conforming loans backed by Fannie Mae and Freddie Mac are capped at $625,500. Anything above that is considered a jumbo loan, and will come with a higher mortgage rate.
FHA Loans Subject to Mortgage Insurance
We’ve talked about some benefits of FHA loans, but there are drawbacks as well.
The major one is the mortgage insurance requirement. Those who opt for FHA loans are subject to both upfront and annual mortgage insurance premiums.
The upfront mortgage insurance requirement is unavoidable, and the annual premium can only be avoided if you have 22 percent or more home equity and a loan term of 15 years or less.
All other borrowers must pay the annual mortgage insurance premium for a minimum of five years, which will clearly increase the cost of the mortgage.
[Note that FHA insurance premiums are also slated to increase!]
Keep in mind that FHA loan offerings are pretty basic. They offer both purchase money mortgages and refinance loans, but the choices are slim.

Should you Refi?

If you don’t mind, let me beat a dead horse.
Mortgage rates are at or near record lows and you could save a ton of money by refinancing.
There. I won’t say it again because I know how cliché and annoying it is to talk about how much money you can save by doing “X.”
The funny thing is I tell my family the same exact thing, though they don’t bother looking into refinancing either.
They bring it up to me here and there, but don’t do much beyond that.
And you can only tell someone something so many times before you give up.
Perhaps this explains why there are millions of homeowners out there with mortgage rates well above current rates that are indeed “refinance able.”
Don’t Have the Time to Refinance?
But for some reason, they haven’t bothered looking into a refinance. Maybe they don’t have any spare time to do so? Or it could be that the task is seemingly so daunting that they avoid it altogether.
Or maybe they don’t want to deal with a shady mortgage lender or a crusty mortgage broker?
The reasons are probably endless, but it still blows my mind that more homeowners don’t take action, considering “how much money you can save!”
It could just be that it sounds so darn “sleazy” to refinance, given all the negative attention the mortgage industry has received over the past five years.
So, how many homeowners are actually missing out?
Well, a couple months back a company named Core Logic noted that twenty million borrowers with positive equity, or 53 percent of all “above-water borrowers,” had above market mortgage rates.
They defined an above market mortgage rate as 5.1 percent (or higher), which is more than a percentage point above current rates for the popular 30-year fixed-rate mortgage.
Pretty surprising, no? I thought the number was high, considering all the news about the “record low rates” that seems to permeate the airways.
But no, many of us still don’t bother, and instead continue making inflated monthly mortgage payments.
All that said, it doesn’t make sense for everyone to refinance all the time. Like anything else in the world, it can be good or bad, depending on your unique financial situation and future plans.