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Should I Refinance? The Rule of Thumb Has Changed

Should I refinance my mortgage loan? For years financial advisors have used a dumb refinancing rule of thumb to answer this question. It used to be that you were told only refinance if your mortgage rate will go down two percent or more. This “dumb rule” left a lot of people that could be saving money out in the cold. The good news is that the mortgage refinancing rule of thumb has changed. Here’s what you need to know about getting best deal on your next home loan.

My “Should I Refinance” Rule Of Thumb

Instead of focusing on only getting the lowest refinance rates use page two of the Good Faith Estimate to figure out how long it’s going to take you to break even. If you can live with the amount of time it takes to recoup your out-of-pocket expenses then the answer to “Should I Refinance” is yes.

How you accomplish this is often easier said than done. Fortunately, there are tools available to help you get it done with spades. Here’s how you can use the new Good Faith Estimate to find the best deal for your next home loan.

What’s new about the Good Faith Estimate?

The old Good Faith Estimate was an unstandardized mess to try and figure out and compare fees. Fortunately, the new Good Faith Estimate makes this much easier. You can make the job of comparing refinance rates and fees much easier on yourself using my mortgage refinance rate shopping rule of thumb.

Refinance rate shopping rule of thumb

In order to be effective, your Good Faith Estimate needs to be used correctly. Before you can do this you need to make a few decisions about which home loan is best for you.

Which mortgage program best meets your needs? Do you need a fixed interest rate with a low payment? Choosing a thirty year fixed rate mortgage loan gets the job done. Can you afford to pay a little extra to build equity in your home? Chose a fixed rate 15-year mortgage loan. Do you have credit challenges and need a mortgage backed by the FHA? The point here is pick a mortgage program and stick with it.

Don’t let a fast talking loan officer confuse you by quoiting refinance rates across different programs.

Next, make sure the Good Faith Estimates you get are zero discount point quotes. If you’d like to see how paying discount points affects your payment amounts there is a comparison table on page three; however, you should always start with zero point quotes.

Finally, pay attention to the loan origination fee, yield spread premium, and service fees found in section A and B on page two of your Good Faith Estimates.

The loan origination fee is paid to the person and or company arranging your home loan. Most loan officers will tell you that one percent is standard; however, I have reviewed community based credit unions that charge as little as $400 for their loan origination fee. Spend some time comparison shopping mortgage fees and you can find deals like this.

What about Yield Spread Premium?

I still get negative comments from people when I talk about Yield Spread Premium. This is a credit paid by the lender when you accept higher refinance rates. It used to be that the broker could pocket this credit along with the loan origination fee as his or her commission.

The rules have changed; however, despite what you may have heard Yield Spread Premium is not illegal.

Really, it’s on your Good Faith Estimate, go look. Item two of section A reads and I quote: “The credit or charge for the interest rate of X% is included in ‘Our origination charge.’ You receive a credit of Y$ for this interest rate of X%. This credit reduces your settlement charge.”

Guess what folks that is Yield Spread Premium! By accepting higher refinance rates you’re paying less for settlement charges. That’s also how those no fee refinance offers work. Keep in mind that higher refinance rates means a higher mortgage payment and more time to recoup your out-of-pocket expenses.

How long will it take you to break even?

Now that you know which fees to look at on your Good Faith Estimate you’ll want to figure out how long it’s going to take up to break even. You can approximate your break-even point by adding up all of the settlement charges and dividing by the amount you’ll be saving each month.

This is only an approximation because there are other factors like term-length that influence your break-even point. As long as you’re not lengthening your term, going from a 15-year mortgage to a 30-year, the approximation works for our purposes.

Do you break even in a reasonable amount of time? What’s reasonable you ask? For some people two years, others four years. As long as you don’t refinance again or sell before recouping your settlement fees you won’t be losing money from refinancing.

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