As mortgage rates normalize in 2022 from the historical lows of the past 12-18 months, it’s essential to know how to find the best refinance rate.
With some insights on how refinancing works, how lenders price loans, what impacts your rates, and how you can lower your rate and closing costs, you can land a great deal on a refinance rate.
There are five steps you can take to make sure you do everything you can to find the best rate:
- Check your credit report
- Clarify your refinance goals
- Choose the right lender
- Compare offers
- Understand the relationship between rates and points
Check Your Credit Report
Find out what is on your credit report. You are looking for your credit score and your debt load, here is why. First, your credit score is one of the big factors that determine your rate, so it is imperative that you know your FICO score going in.
A difference of 1 point on your credit score can help you get a refinance rate that is .125 (⅛) to .250 (¼) of a percent lower. That may not seem like much all by itself but let’s say you currently have a 6% rate on your current loan. A FICO score of 639 could get you a 5% rate, and a FICO of 640 could get you down to 4.875%. Getting that extra ⅛ or ¼ of a percent off could make the difference between deciding to refinance or not.
Another area where this might help is the impact your Loan To Value (LTV) ratio and your current FICO score have on rates. Lenders use a system called Loan Level Pricing Adjustment (LLPAs) to determine the rate you will be offered based on the characteristics of your loan.
If you have a 639 FICO score and you are at 75% loan to value ratio, you will get a higher rate than if you have a 640 FICO score at the same 75% LTV. In a case like this, having a 639 FICO would give you two bumps higher on the rate, one for FICO score and one for LTV.
Here is how it pays to know what is on your credit report. FICO scores are impacted by a few factors. Your payment history is at the top, second is your percentage of credit available to credit used.
Here is an example of how this works. If you have a total credit limit of $10,000 and you are using up $8,500 of it, your FICO score will take a huge hit because you are using 85% of your available credit. So what can you do?
There are multiple ways you can lower the percentage of credit you are using. Let’s say you have a savings account, you can use that to pay down some of your debt, enough to get that 1 or 2-point bump, maybe even more, so you can get a better rate.
You can also request an increase to your credit limit from the credit card companies, which will then lower your percentage of credit used.
A good lender will help you through this process, but it is a good idea for you to know upfront what you are facing.
Clarify Your Refinance Goals
This may seem obvious at times, but there are nuances to refinancing you should pay close attention to. Here are some things to consider:
- Are you just looking to lower your current loan rate?
- Do you want to shorten the term of your loan?
- Would it make sense to take cash out and consolidate high-rate credit card debt and car loans?
- Are you looking for the best rate or the lowest cost?
It is not uncommon for borrowers to just think of the benefit of lowering the current rate without considering the rest of the options available.
Many times the mention of consolidating debt brings anxiety to people. A common comment is, “why would I want to add my unsecured debt to my mortgage?” There is that fear that if they fall behind on the mortgage because of the newly added debt, they could lose their house unnecessarily.
Yet, people keep on paying the 24.99% rate compounded daily on credit cards for decades when they could have reallocated that debt to a 5% compounded monthly rate if added to the mortgage. The difference in cost for not doing so is substantial, but the difference in the collective amount of debt is ZERO. So borrowers pay 8-10 times more for the same debt due to fear.
Deciding on whether or not to go from a 30-year loan to a 20 or 15-year is also an important consideration. For many people, there is relief in knowing that instead of starting off again on another 30-year loan, they can shorten the time to be mortgage free.
One thing to consider, 15-year rates are lower than 30-year rates. Being clear on the goal may help you come out even better than you had anticipated.
Another thing to consider is whether you are looking for the lowest rate or you want to lower the costs of refinancing. Here are some examples that play out in the marketplace every day.
A borrower has 6% interest with PMI at .75%. This is a combined effective rate of 6.75%. If you can lower your rate to 5.25% and it costs you nothing, that is something worth considering vs. getting down to 4.75% if it is going to cost you $6,000 to do so.
Have a clear idea of all these areas so that when you speak with lenders, you can ask the right questions.
Choose the Right Lender
Not all lenders are the same. Understanding the difference between a direct-to-consumer lender, a retail lender, and a state or federal bank can save you some good money. Know before you decide.
One common error that many borrowers make is to just call their current lender and refinance with them. Borrowers usually cite that “they already have all my information anyway” as the reason to just go with them.
What they don’t realize is that, by law, sensitive information that is part of the loan file, such as income, credit, and assets, is not allowed to be shared between departments. Consequently, the loan origination department has no access to the customer’s current loan file because it is housed in a different department. The loan officer has to start a brand new file all over again, so there is practically zero benefit to staying with the current lender without exploring other options.
Make sure to talk to at least three lenders so you can have more than one option and get the best loan and the best rate on your refinance.
As we mentioned above, do your due diligence and compare offers from different lenders. You are looking to see not only who has the best rate but also the lowest cost.
Look closely at lender fees and the fees of ancillary services such as title and settlement fees. Fees such as loan origination, processing and underwriting fees can vary quite a bit from lender to lender.
Additionally, some lenders have special relationships with title and settlement agents that lower the cost of those fees for borrowers.
The best way to compare fees is to look at the Loan Estimate (LE) that lenders have to provide on every loan application. Make sure you compare estimates from at least three different lenders.
Understand the Relationship between Rates and Points
One of the most important components of getting a good deal on your refinance is understanding how rates and points affect each other.
In a nutshell, you can pay points to buy down your rate. You can also take a higher rate to lower or eliminate points and costs altogether.
Although some of this may be familiar to you if you have shopped for a loan before, here is something you may not know.
Depending on the rates offered by the lender, there are different costs/benefits to the same rate buydown or buyup.
Let’s say that today’s “best execution rate” (An insider term that means the best rate, at the best fees) is 5.25% at ¼ point. Very often, if someone is set on getting 5% will ask how much it would cost to get 5%. The relationship between rates and points is usually 1 point in exchange for ¼ of a percent in rate up or down. In this example, normally, it would cost an additional 1 point to get down to 5%.
However, that is not always the case. In some environments, it may cost 1.5 points to get that extra ¼ percent lower in rate – 50% more than it normally would. The reasons for this have to do with the coupon rates of Mortgage Back Securities. We will spare you the brain damage of diving deep into that. Just know that the relationship between rates and points can vary, it is not always linear.
The good news is that this can also act in your favor. You may be able to take a ⅛ of a percent higher in rate and get ⅜ points rebate (credit towards closing costs), whereas it would normally be a smaller credit than that.
So the thing to do is to ask your lender(s) what the cost or credit is at different rates.
It is said that “knowledge is power.” When you shop for the best mortgage rate for your refinance, knowledge can also equate to getting much better rates and fees on your refinance, which translates into hard cash in the end.
Use this info when you shop for a mortgage, it will pay off dividends for years to come.
Always talk to a professional, licensed mortgage advisor who you can count on and who you feel has your best interest in mind.