Getting the best interest rate on your mortgage refinance depends on several different factors, ranging from your loan type and your credit score to how much time you want to spend shopping across multiple lenders. Researching your options and understanding your goals will help you save money and move forward with confidence.
Why Should I Refinance My Mortgage?
Knowing why you're refinancing will help you make objective decisions and weigh your options logically. Consider your future plans for your home. Are you planning on selling your home in five years to downsize or cash out on your investment? Or are you planning on staying there for the long run?
On the surface, getting a lower interest rate or lowering your monthly payments could be strong motivating factors. But there could be other objectives you may wish to consider. The considerations below can help you decide whether you want to refinance into a lower interest rate, into a shorter loan term or cash-out on your home equity.
- Will a lower monthly payment allow you to save for your children's college education?
- Will a shorter loan term mean that you can enter retirement without worrying about mortgage payments?
- Do you need to take out cash to remodel your home?
The best way to approach a potential refinance is by gathering information. There are many ways you can approach a home refinance other than simply refinancing into a lower rate. Before reaching out to lenders, first use a mortgage calculator to determine what your monthly payments might look like under different refinance scenarios. This will help you decide which options meet your goals. Once you've selected the type of refinance you want, it will be easier to compare rates from different lenders for the specific terms you want.
How to Get the Lowest Mortgage Refinance Rate
Improve your credit score. In general, the better your credit rating, the better the interest rate you'll receive. Qualifying credit scores are the minimum scores that a lender will accept for a particular program. However, the best pricing and interest rates are only available to borrowers with top-tier credit. Consider the following scenario: With a credit score of 680, you may qualify for a 4.5% interest rate on a 30-year $250,000 loan. But with a credit score of 720, you could qualify for a 4.0% rate on the same 30-year loan. At 4.5%, you'll pay $206,017 in interest over the life of the loan. By contrast, at 4.0%, you'll pay just $179,674 in interest over the life of the loan. That's a difference of $26,343.
Depending on the size of your mortgage, a few percentage points can add up to a substantial amount of interest over the course of 30 years. It's worthwhile to boost your credit score as much as possible before applying for a refinance. You can do this by paying down debts, checking your credit report for errors or omissions, and resolving any negative marks.
Adjust the Duration of Your Loan. Shorter-term loans typically carry lower interest rates than longer-term loans. This is due to the relative risk carried by the lender. The longer it takes you to pay back a mortgage loan, the more likely that a lender's investment could be diminished by inflation and other market factors. Lenders, therefore, set higher rates on 30-year loans than on 20- or 15-year loans in order to compensate.
Having a loan term of 15 years or less, as opposed to 30, is desirable because of the lower interest rate and shorter amortization period. Even if the interest rates on both loans were identical, the total cost of a 15-year loan will still be significantly lower due to the shorter time period in which interest accrues. A 15-year $250,000 loan with a 4% rate will cost you $332,860 over the life of the loan. By contrast, the same $250,000 loan, over 30 years will cost you $429,674. That's a difference of $96,814. Cutting down the length of your loan can save a lot of money over time, but borrowers should be careful not to raise their monthly payments to unmanageable levels.
Improve your Debt-to-Income Ratio. Your debt-to-income, or DTI ratio, is an important factor that's used to determine whether you'll be approved for a loan and what interest rate you'll get. Consider lowering your debt load by paying down balances on other installment loans or revolving debts before applying to refinance your mortgage. Simultaneously, you should also avoid applying for new credit or purchasing any big-ticket items that might increase your DTI ratio, as this will negatively impact your mortgage application.
Increasing your income will also improve your DTI ratio, so include additional sources of verifiable income on your application whenever possible. This can include income from rental properties, side jobs or even pension checks. Just keep in mind that it will need to be documented just as thoroughly as your primary source of income when reported to your lender.
Shop around with multiple lenders. Comparing rates and terms with a few different lenders is vital to securing the best interest rate for your mortgage. Keep detailed notes on each option that's presented to you, and always compare interest rates between lenders on the same day. The mortgage market is in flux, so comparing quotes across different days or weeks may make them less accurate and comparable.
In order to receive the most accurate quotes, talk with a loan officer, who works for a lender directly, or a mortgage broker, who works on your behalf. They will need specific information about your property, income, assets and credit profile. Always make sure you're comparing the same loan terms and factors when shopping for rates, as this will ensure you're comparing loans on an apples-to-apples basis.
Factor in both interest rate and closing costs. It's important to determine whether you're paying to receive an interest rate that's lower than market average, or if you're receiving a credit for choosing a rate that's above market average. The lower the interest rate is below market average, the more you'll have to pay to secure it. This is where the term "paying points" comes from. The amount that you pay is a fractional percentage point of your loan amount.
Keep in mind that there is no such thing as a "no-cost" loan when mortgage shopping. There are always transactional costs for creating and closing a loan, which will either be reflected in your costs to close or a higher interest rate. When lenders tout no-cost options, they're referring to a loan with a rebate large enough to counteract or even completely cover any closing costs. This higher interest rate is known as the yield spread premium, and it's effectively the opposite of paying points. In this situation, your "no-cost loan" is essentially offset by the higher rate you receive. This should be kept in mind if you think you’re getting a deal with a no-closing cost mortgage loan, but may not deter those who are trying to avoid upfront fees.
Learn about specialty financing programs. Streamlined refinance programs are offered through the Federal Housing Administration (FHA) and Department of Veterans Affairs (VA) to borrowers with outstanding FHA and VA loans. They're designed to allow you to take advantage of the financial benefits of refinancing while reducing closing costs. These programs usually require less documentation, waive appraisals and other closing costs, and are processed faster than conventional refinances. Not all borrowers will qualify for these types of refinances, but they're worth looking into if you already have an outstanding FHA, VA or other government-sponsored mortgage.
Compare your Loan Offers. Quotes for mortgage loans are often expressed as two types of rates: A simple interest rate includes the long-term finance charge of the mortgage, and an APR, or annual percentage rate, that includes the simple interest rate plus any fees or closing costs associated with the loan. In order to accurately compare offers, you should compare mortgage loans on the basis of APRs rather than simple interest. Keep in mind that APR isn't the rate used to calculate your monthly payments. Rather, it is a reflection of your interest rate plus added costs of financing.
Manage your expectations and Increase Your Knowledge. It's important to identify the type of loan you'll need based on three key factors: your property type, occupancy type and refinance purpose. Interest rates are typically higher for investment properties, multi unit properties, and cash-out refinance transactions. The majority of the published interest rates you'll see are for single-family primary residences, on a rate and term basis (no cash-out). Being educated and informed about the refinance process will ensure that you have realistic expectations and can confidently make a decision when the opportunity presents itself.