Refinancing when mortgage rates fall allows homeowners to save on their monthly payments with a lower interest rate than their current loan, and cut the total amount of interest paid on the loan.
Homeowners should consider refinancing if they can shave one-half to three-quarters of a percentage point off a mortgage loan, says Greg McBride, CFA, chief financial analyst for Bankrate.
Here are some ways that will help you get the best mortgage refinance rate.
1. Improve your credit score
While there are no quick fixes to improving your credit score aside from correcting any errors made to your credit report, paying down a large credit card balance with a lump sum can help reduce your debt-to-available credit ratio.
“There aren’t many ways to quickly improve your credit score,” says Jackie Boies, a senior director of housing and bankruptcy services for Money Management International, a Sugar Land, Texas-based nonprofit debt counseling organization. “Applying good credit practices over time is how you improve your score.”
The largest component of a credit score is whether you pay your bills on time, so being consistent in this area is critical, McBride says.
Other factors used to calculate your credit score include the amount owed, length of credit history, new credit and types of credit used. Avoid using over 30 percent of your available credit on a credit card, and don’t close the old accounts that you paid off, because it lowers your amount of overall available credit.
2. Compare mortgage refinance rates
When looking to refinance and save, compare as many mortgage offers as possible. Even a fractional difference can save thousands.
When you compare interest rates, consider the APR, or annual percentage rate, as well, which encompasses annual fees and gives you a better idea of what the true cost is. You may find that the mortgage offer with the lowest advertised rate has higher fees and closing costs that don’t make the rate as attractive.
3. Buy points to lower your interest rate
Homeowners can buy points to lower their interest rate. In other words, you pay the lender upfront for a lower rate over the life of the loan. One “point” is equal to 1 percent of the loan amount.
Bruce McClary, spokesperson for the National Foundation for Credit Counseling, a Washington, D.C.-based nonprofit organization, says homeowners should negotiate the terms of the loan where they can. In addition, meeting all of the mortgage approval guidelines helps avoid having to pay more for what you borrow. This includes interest and prepaid points.
“Those with healthier credit scores have more negotiating power than those with average or low scores,” McClary says.
Getting more than one quote is also important. Lenders offer a variety of programs, ranging from “no points and out-of-pocket costs with a higher rate to those requiring more points upfront by permanently buying down the rate,” McBride says.
Homeowners short on cash should avoid depleting their reserves just to buy down the rate, however.
“Only do so if you can spare the cash and plan to be in the loan for a long enough time to reap the benefit of the lower rate,” McBride says.
4. Determine which loan term is best
While shorter loans such as a 10-year fixed or 15-year fixed carry lower rates than longer loans, the tradeoff is much higher payments — and that can be problematic if a job loss occurs.
“Homeowners shouldn’t stretch and saddle themselves to large payments that limit their flexibility just to save half a percentage point or so,” McBride says. “Maintaining financial flexibility is important.”
A longer mortgage term can help keep monthly payments low, but the loan will be costlier to repay because more interest is charged over time, McClary says.
5. Go for the fixed interest rate
The value for homeowners is in fixed rates, since there is little difference between fixed rates and the initial rate on adjustable mortgages, McBride says.
“Go for the permanent payment affordability of the fixed-rate loan,” McBride says. A fixed rate can also help consumers budget more easily.
When rates are already fairly low, but could possibly increase in the foreseeable future, it makes sense to get a fixed-rate loan, McClary says.
“This is also true for those who plan to remain in their home for longer periods of time,” McClary says. “If it’s possible that rates could drop in the near future or the property could sell before the loan is repaid, a variable-rate loan could be the way to go.”
With a variable or adjustable-rate mortgage (ARM), the interest rate changes at predetermined intervals based on the market and a margin determined by the lender. So, while your interest rate can decrease at those times, it can also increase substantially — making a fixed-rate loan generally less risky.
6. Watch that loan amount
The more you borrow for a mortgage, the higher your monthly payment will be. A homeowner who gets a mortgage on a $250,000 home with a 4 percent interest rate for 30 years and a 10 percent down payment pays $1,195 a month, while a 20 percent down payment brings that down to $955, Boies says.
“You will want to consider the long-term savings over the life of the loan,” Boies says.
While it is easy to get confused when presented with all the options for refinancing a mortgage, there are many resources available for help.
“A HUD-approved nonprofit agency affiliated with the National Foundation for Credit Counseling can offer some expert advice and direction for making the right decision,” McClary says.
Borrowers need to fully understand the terms of their mortgage loan, as well. Utilize online calculators to help make decisions and find a mortgage that best suits your needs, Boies says.
Featured image by Kirkikis of Getty Images.