Low mortgage rates have kept the housing market among the few bright spots in a dark year, particularly for the wave of homeowners easing their cash flow with a mortgage refinance or switching to a shorter loan term.

Refinancing is anticipated to account for approximately $1.75 trillion of the more than $3 trillion in mortgage financing in 2020, according to the Mortgage Bankers Association in Washington.

But not every homeowner can refinance at the low rates advertised each week. A wide range of factors goes into individual mortgage rates, including a borrower’s credit scores, debt-to-income ratio, and home equity.

And now there’s a new “adverse market refinance fee,” which took effect Dec. 1. The Federal Housing Finance Agency (FHFA) has imposed a 0.5% fee on refinance loans, which comes to $1,000 on a $200,000 loan.

In most cases, banks will absorb the fee and charge a higher interest rate for the refinance. The difference would amount to an interest rate of 2.58% vs. 2.5% for a 30-year mortgage.

“After the financial crisis in 2008, there was a fee on loans to help backstop losses,” said Brian Gilpin, vice president of capital markets for Embrace Home Loans in Middletown, R.I. “The government is trying to do the same thing now.”

Millions of Americans have filed for unemployment during the pandemic, and the fee will mitigate some of the higher risks and costs lenders have incurred while adjusting their policies to accommodate coronavirus protections such as mortgage forbearances and eviction moratoriums.

Justin Rosenal, vice president of the Pittsburgh region for Union Savings Bank in Richland, said that the mortgage market is flooded with refinance applications, and he doesn’t see it slowing down soon.

“This is the first time I’ve seen in 30 years in the business that it’s taking 90 to 100 days to do a refinance because the market is so overwhelmed,” Rosenal said.

If you’re thinking about refinancing your home, here’s what you need to know.

Risk factors

For lenders, each mortgage loan requires evaluating the risk of the borrower defaulting on the loan.

“The riskier the loan, the more the lender wants compensation for that risk and will charge a higher interest rate or fee,” said Patrick Boyaggi, CEO of Own Up, a Boston-based mortgage technology company.

Among the risk factors that lenders evaluate are:

  • Credit score. Conventional loans have tiered rates based on your credit score, with the lowest mortgage rates offered to borrowers with the highest credit scores. The top tier, according to myFICO.com, is for borrowers with a credit score of 760 and above.

  • Home equity. Your rate will vary according to how much of your home value you’re borrowing. While some lenders will allow you to refinance up to 95% of your home value, your mortgage rate will be higher when you refinance more than 80%, said Kevin Parker, vice president of field mortgage operations for Navy Federal Credit Union in Hyattsville, Md.

  • Type of property. Typically, a second home or investment property will have a slightly higher mortgage rate than a primary residence because borrowers are more likely to default, if they must, on a vacation home than their primary residence. Condos carry a slightly higher risk and therefore have a slightly higher rate.

“Your rate also depends a lot on the lender you choose, because different lenders have a different appetite for risk,” Boyaggi said. “Your mortgage rate can vary by as much as 0.5% or 1% for the same loan from different lenders.”

Most lenders use an automated system to evaluate a borrower’s ability to refinance or purchase a home, said Paul Buege, president and CEO of Inlanta Mortgage, based in Pewaukee, Wis. The automated systems are tweaked often, so sometimes someone who might have qualified a year ago won’t qualify today.

The Mortgage Bankers Association’s data from its credit availability index showed that lenders have tightened credit this year because of their concern about the job market.

In addition, the association reported that tightening in some conventional and government loan programs that had previously allowed for lower credit scores, lower down payments, and reduced documentation is driving the overall decline in credit availability.

Nearly three-fourths of all refinances that closed in October were for borrowers with a FICO score of 750 or higher, according to Ellie Mae’s Origination Insight Report.

Sixty percent of all mortgage loans closed in October were refinances, with the average time to close a refinance at 54 days, according to Ellie Mae.

Borrowers should anticipate several verifications of their employment from lenders, including just before the closing. If you have lost income or your job, a refinance may still be possible depending on other sources of household income and your debt-to-income ratio, which compares your minimum payment on all debt with your gross monthly income, Parker said. However, unemployment benefits cannot be used to qualify for a loan.

"Talk to a lender to establish a plan so you can refinance and take advantage of low rates in the future even if you're not able to qualify now," Buege said.

Why refinance?

Low mortgage rates encourage homeowners to look into refinancing, but it's not always the right decision for every borrower. Homeowners need to pay closing costs on a refinance with cash or by wrapping them into their new loan balance, so it's smart to calculate when you will recoup those costs.

“While some people look for a rate change of at least 0.5% to make a difference, the bigger your loan balance, the less you need a big interest rate change to save money,” Buege said.

Gilpin said a difference of one-fourth of a percentage point can mean significant savings on a loan balance of $200,000 or more. For balances under that amount, most borrowers would want their rate to be at least one-half of a percentage point lower.

"We're seeing a lot of people switch from a 30-year loan to a 15-year loan to save on overall interest and pay off their home faster," Gilpin said. "If someone has been paying on their 30-year loan for six or seven years and they refinance into a 15-year loan, they're saving eight years of payments."

Many borrowers are also refinancing from an FHA or conventional loan with mortgage insurance to a conventional loan without private mortgage insurance, Gilpin said.

“Home values have been appreciating quickly this year, so a lot of borrowers are able to save significantly by getting rid of their mortgage insurance with a refinance,” Gilpin said. Mortgage insurance is required with all FHA loans and on conventional loans with less than 20% in home equity.

Improving your cash flow with a lower mortgage rate, eliminating mortgage insurance and shortening your loan term are not the only reasons to refinance. Buege said cash-out refinancing, which refers to borrowing more than your current mortgage balance, is popular for debt consolidation or to pay for a home improvement.

“Like most lenders, we have digital tools on our website that you can use to do the math to check the difference in your monthly [payment] if you refinance,” Parker said. “You can see several options, including monthly payments and closing costs to decide if it makes sense to refinance.”

Up to 18 million homeowners could save as much as 1% on their mortgage rate by refinancing, according to the analysis by Ellie Mae. But for each borrower, it’s important to consider a refinance in the context of their long-term financial plan and to work with a lender who can advise them about all the consequences of a refinance.

The article includes reporting from Tom Grant of the Pittsburgh Post-Gazette.