When it makes sense to refinance

By Sabrina Karl

When you took out a mortgage on your home, chances are you choose the best option for your needs at the time. But because personal and financial situations change, as do housing markets and interest rates, the best mortgage for you today is not always the same one you currently own. That’s when it may be time to refinance.

Even though refinancing isn’t cost-free, it can be a smart move for a wide range of reasons. Probably the most common motivator is to lower your mortgage interest rate. If currently available rates are 1 percent or more below your existing APY, refinancing may be worth the cost to lower the amount of interest you pay and therefore your monthly payments.

Others will refinance to change the length of their term, either shortening it, for example, to be debt-free by retirement, or lengthening it in tandem with lowering their rate because they want or need to minimize their payments.

Another attractive reason to refinance is if you hold an adjustable-rate mortgage (ARM) and either decide you’ll be in the house long enough to make a fixed-rate mortgage pay off, or see that your ARM is now charging more than currently available fixed-rate mortgages.

But there’s still another frequent reason for refinancing, and that’s to turn home equity into cash for other purposes. If you refinance to a loan amount that’s higher than your current mortgage balance, you’ll receive the difference in a payout. Many homeowners take advantage of this opportunity when they need to fund a large purchase or a home renovation project. Others will do a cash-out refinance to consolidate debt, such as paying off high-interest credit card balances.

In any case, refinancing involves costs and potential risks, so it’s important to weigh these carefully against your calculated benefits.

Why 15-year mortgages are worth a look

By Sabrina Karl

The 30-year fixed mortgage is the apple pie of home financing, with roughly 9 in 10 borrowers choosing the long-term option. But that doesn’t mean it’s your only or best choice. For many homeowners, a shorter 15-year loan offers considerable savings.

There are just two differences between 15- and 30-year mortgages: first, the length of the term, and second, because the lender’s risk with you lasts 15 years instead of 30, the interest rate. A rule of thumb is that 15-year rates run about 0.75 percent lower than their 30-year siblings.

For most borrowers, the choice comes down to affordability. A 30-year loan offers the lowest monthly payments, allowing the flexibility to buy a more expensive home than you could with a 15-year term, or leaving more money for competing priorities such as retirement or college.

But with a higher rate and a twice-as-long term, the 30-year mortgage will ultimately cost a great deal more than the 15-year option. Over 30 years, a $150,000 mortgage at 4 percent will cost about $258,000. Meanwhile, borrowing the same $150,000 for 15 years at 3.25 percent will cost just $190,000, saving you almost $70,000.

Of course, the benefit doesn’t come without its trade-off. The monthly payment for the 30-year loan will run about $716, while the 15-year mortgage will require committing to a $1,054 payment.

Still, if you can afford the higher payment and your income is reliable, the 15-year term will save a considerable sum, and get you debt-free sooner. Indeed, it’s a particularly great option for those approaching retirement.

Want the 15-year savings but leery of committing to higher payments? A hybrid is to take a 30-year loan but make payments at the 15-year level, still saving a substantial amount while retaining your option to make lower payments during lean times.

Home equity loan vs. HELOC

By Sabrina Karl

If your home’s value sits well above your mortgage balance, tapping into that equity for home improvements or consolidating debt can be a smart financial move. Both home equity loans and lines of credit allow you to do that, so which should you choose?

Both access the value in your home that belongs to you, but that you otherwise wouldn’t reap until selling the property. Both also offer lower interest rates than credit cards and personal loans since they’re backed by your home’s collateral, with the added bonus of the interest being tax-deductible.

The difference lies in how you’ll access the money. A home equity loan is like most other loans you’d request from a bank, where you apply for an amount and, if approved, the bank extends a lump sum at a fixed interest rate.

Home equity lines of credit, or HELOCs, work more like a credit card. The bank sets a limit based on your equity and lets you draw from the HELOC as needed, usually at an adjustable rate. Banks generally offer HELOC access via checks and bank transfers, with some also providing a debit card.

How you’ll use the funds will determine the better fit for you. Consolidating higher-interest debt? Then a home equity loan will work well, giving you a lump sum to pay off those balances and convert them to a single, more affordable payment going forward.

But if you’re tapping funds for home improvement, paying contractors throughout the project, a HELOC lets you borrow the money in flexible amounts at different times. A HELOC can also be useful as an emergency cushion, sitting untapped unless you need it.

With their low interest rates and tax advantages, home equity loans and HELOCs are among the most valuable financial tools available to homeowners with built-up equity.

How high a credit score do I need to get a good mortgage?

By Sabrina Karl

Whether you’re applying for a new mortgage or just refinancing, your three-digit credit score will factor heavily into how attractive a rate you can get, or if you’ll be approved at all. While those with the highest scores enjoy the lowest rates, mortgage lenders classify applicants into four tiers of scores to determine their offer.

The credit rating lenders rely on is your FICO score, which ranges from 300 to 850 based mostly on how often your payments have been on time, how much you owe, and how long your credit history is

Generally, the lowest score that can secure a mortgage is 620. One big exception is the government’s FHA program, which helps those with subprime credit. While an FHA loan can be secured with a score as low as 500, or 580 for the low-down-payment option, most applicants with scores this low are denied.

Once you surpass 620, you’ll have more options – and a chance at better rates – from conventional bank lenders. Boost your score higher to 660 and the number of lenders willing to take your application will increase again, with rates coming down further.

The next threshold is a score of 700 or better. Applicants with these “very good” scores have exceptional odds of approval, and the rates offered will be close to the best available.

So what then is the brass ring that earns the very best rates? That threshold generally sits around 750. Some lenders set the bar at 760, while others have published a 740 minimum, so it’s worth asking any lenders you approach what threshold they’ve set.

Knowing your score before applying for a mortgage can be a money saver if you find you’re close to the next tier. A few smart credit moves might be all it takes to earn yourself to a better rate.

What are mortgage points and should I pay them? →

By Sabrina Karl

One of the most confusing mortgage choices is whether to pay points. It doesn’t help that the term is used two different ways, or that the right answer varies by situation. But the good news is that you can boil your decision down with a simple math calculation. 

A “point” refers to one percent of your loan amount. So on a $200,000 mortgage, one point equals $2,000. You also need to be aware that lenders quote two kinds of points. Origination points are a fee you pay the lender for their services, and you may or may not be able to negotiate it.

But discount points are different, and are the ones borrowers find themselves dithering over. A discount point is a pre-payment of interest at the time of closing in exchange for a lower mortgage interest rate. It allows you to “buy down your rate”.

Lenders often let you pay one to three points, but we’ll use an easy one-point example. Opting to pay a point at closing typically lowers your mortgage APR by about a quarter percent (though lenders vary). So for a $200,000 mortgage with a 30-year fixed rate of 3.75 percent, paying one point, or $2,000, could lower your rate to 3.50 percent, which would drop your monthly payment from $926 to $898.

Now divide the cost of the point ($2,000) by the monthly savings ($28) to see how long it will take to break even. In our example, it would take 72 months, or six years, to earn back your $2,000 investment. Expect to stay in your home longer than that? Then buying points makes good sense.

Of course, if you can’t afford to bring more money to closing, or you have a higher-priority use for your funds, a no-point mortgage will be your own smart mortgage choice.