If you're a homeowner with no plans to move anytime soon, you can take advantage of historically low interest rates by refinancing your home. While this can be a smart financial decision, there are five facts about the process that might surprise you.
It Can Cost You Thousands To Refinance
This is one of the things that surprises a lot of homeowners. To take advantage of low interest rates, you might actually have to pay for it! As part of refinancing your home, banks treat the transaction just like a new purchase. That means the borrower might be asked to pay for an appraisal and closing costs. Typically, closing costs range anywhere from 2%-3% of the loan amount. For example, if you were refinancing $150,000, it’s reasonable to budget $3,000-$4,500 to cover closing costs.There is a silver lining if you're in the military, however; COVID-19 has had little affect, if any, on the benefits that VA loan lenders like Veterans United offer on a regular basis. (That may be why Veterans United actually closed out 2020 with a record number of loan originations!)
It Can Cause Your Taxable Income To Increase
Each year, homeowners are allowed to deduct mortgage interest paid on their taxes. This deduction decreases a homeowner’s overall taxable income. However, refinancing your home to a lower interest rate, could also decrease this deduction. Depending on the interest rate and loan amount, the change could be minimal or significant, and it does have the potential to bump a homeowner into a higher tax bracket. It’s important to consult a CPA prior to refinancing to better understand the tax consequences for your specific situation.
You May Need An Appraisal
Almost all lenders will require an appraisal of the property during the refinance process. The purpose of an appraisal is to determine the value of a home. This is typically a service that can cost several hundred dollars and paid for by the homeowner.[caption id="attachment_326625" align="alignnone" width="2560"]
External-only appraisals have become more common during COVID-19.[/caption]It should be noted that the COVID-19 climate has changed some of these typical requirements. For example, many lenders are now accepting external-only appraisals, or not requiring them them at all. These provisions tend to favor those who have healthy loan-to-value ratios and stronger credit scores, so make sure you're consistently monitoring your credit.
If You Plan To Move Soon It May Not Be Worth It
Since refinancing your home can cost thousands of dollars, it’s important for that investment to be worth it. While the reduced interest rate may decrease your monthly mortgage amount, if you move soon after refinancing you may not recoup the thousands you paid in the process. Not to mention that in the selling process you will have to pay closing costs again.One way to navigate this is to try and negotiate an interest rate higher than the market low in exchange for lender credits that you can apply to closing costs. For example: If you currently have a 5% interest rate and qualify for a market low of 3%, but don't want to pay thousands in closing costs, see if the lender will give you a higher rate (say, 3.25% or 3.5%), and in exchange they will shoulder some or all of the closing costs. You would certainly pay more if you stayed in the home for the life of the loan, but if you think you might move within a few years, this could be worth trying to negotiate.
You Need Significant Equity In Your Home
While home values have continued to skyrocket, those that purchased prior to the Great Recession-era housing market crash may not have recovered the value of their home yet. When a homeowner owes more than the current market value it’s called being upside down. For those homeowners that are still upside down on their home, a refinance may not be possible. Each lender’s equity requirement can vary, so it’s important to consult a loan officer before beginning the process.Refinancing can be a great way to reduce your monthly payment, pay more towards your principal, and shorten the life of your loan. With rates so low, refinancing your home can certainly be a wise move. However, homeowners should know it may not be a cheap or fast process. If you’re considering a refinance, consult a local lender to see if it’s a scenario that would benefit you!