Just as deciding when to take advantage of 4th and goal, refinancing a home has many opportunities and pitfalls.
The reason you might consider a refinance is that you want to pay less interest. Or, if you need to put some money towards another expense, you can take some money out of your house. It’s even possible you want to shorten your term.
These are all good reasons to refinance. However, if you want to maximize these benefits, as well as take advantage of the current market, which favors refinancers since mortgage rates are at record lows, you could make a hasty decision that’s not right for you.
Considering a home refinance now? Here are twelve costly mistakes you should avoid so you can score a touchdown with a refi.
1. Taking only interest rates into account.
Whenever interest rates drop, many people think about refinancing. A lower interest rate might lower your monthly mortgage payment, but there are other things that will affect it. For example, there might be a drop in interest rates, but are they below what you financed your home at? Did your credit score drop since you first financed your house? Can you cover closing costs with your savings?
Remember, getting a refinance is like getting a new loan. That means you’ll have to pay closing costs and your lender will look at your credit score. Therefore, before you refinance, make sure you compare your current interest rate with today’s rates, review your credit score, and make sure you can afford closing costs.
2. Not shopping around.
When you need a home loan or a refinance, you might be tempted to go right to your regular bank. Or maybe you just check a few lenders and pick the cheapest one. And, plenty of people think they have to refinance with their current lender.
Here’s the thing though. When you’re refinancing your mortgage, you need to research your options. You can save tens of thousands of dollars over the life of your mortgage with a difference of just one-eighth or one-quarter percent.
Mortgage pricing can also be tricky, with many factors affecting the actual cost, so compare rates, terms, and fees from different lenders carefully. You’ll also want to use a refinance calculator to help you determine what your new monthly payment will be.
In short, don’t rush when it comes to refinancing your home so that you’ll find the best idea available.
3. Restarting the clock for another 30 years.
Whenever you refinance your mortgage, you should avoid restarting the clock to another 30 years on your new mortgage, advises Alvin Carlos of District Capital.
“This means that if you’re already five years into your mortgage, you don’t want to extend your mortgage and pay over a period of 30 years when you would have just paid over a remaining period of 25 years,” Carlos explains.
Another 30 years may seem appealing since it will lower your current monthly payment and may seem like immediate savings. However, if you reset the clock to 30 years instead of 30, you’ll pay significantly more interest than you would have had you kept the original 30-year mortgage.
“To avoid this, you can request that your lender amortize the newly refinanced mortgage over 25 years rather than 30,” suggests Carlos. “Alternatively, you could do the math and figure out how much more monthly you need to pay on the loan to pay it off in 25 years rather than 30, and then set that up to automatically pay each month.”
4. Choosing a mortgage with no closing costs.
Again, refinancing your mortgage is basically getting a new loan to replace the old one. So you’ll have to pay closing costs to finalize the deal. Typically, closing costs range from 2% to 5% of the loan amount. If you’re getting a $200,000 loan, for example, you can expect to pay between $4,000 and $10,000.
Luckily, there are no closing-cost mortgages out there. But, as with most things in life, there’s a catch. In order to make up for the money they lost upfront, the lender may charge you a little more interest. It can make refinancing much more expensive over time.
To show how the cost breaks down, here’s an example. Imagine you have a choice between a $200,000 loan at 4% with closing costs of $6,000 or a $200,000 loan with no closing costs at 4.5%. Not much difference, right? Well, if you opt for the second option, you’ll end up paying thousands more over 30 years.
5. Don’t refinance at the wrong time.
When is the best time to refinance? Preferably, it’s when you’ve got your finances in order. At the minimum, this means you’ve been making payments on time and are a valuable customer.
In addition, you should consider what you hope to accomplish when determining when the time is right. As an example, you might do better to wait until the fixed-rate loan has ended before starting a new term, rather than refinancing and incurring break costs if your fixed-rate loan is nearing its end. Before refinancing, take into account your future plans (renovation, investment, starting a family). You should be able to meet your future needs.
Consolidating debt is a valid reason to refinance. As an example, if you consolidate $40,000 in credit card debt into your $250,000 home loan, your revised loan amount will be $29,000. However, a shorter loan term is available for the $40,000 portion. Even if the rate of interest on your short-term debt is lower, you will end up paying more in interest if you extend the term over which you pay it to the full term of your mortgage.
6. Over-estimating the value of the home.
“Just because your home was worth $300,000 seven years ago doesn’t mean it’s still worth that,” Ilyce R. Glink writes for CBS News. “Nationally, home prices have fallen more than 30 percent, with some markets (Las Vegas, Phoenix, and Miami come to mind), falling much more.”
In other words, if you don’t have enough equity, your refinance offer will be higher than you expected.
7. Saving too little.
Getting a small reduction in your interest rate, such as half a percentage point, will take you a long time to recoup your closing costs. This is called the break-even point. More specifically, this is the point when you save enough from refinancing to pay for refinancing.
As an example, you may have paid $5,000 in closing costs and saved $100 a month by refinancing. You will reach break-even in 50 months, or just over four years. However, if you save only $50 a month, you’ll have to wait eight years to break even. What’s more, you might already have sold your home by then as well.
A refinance is worthwhile if you can lower your rate by at least three-quarters or a full percent. In high-end homes, lower rates can be justified because savings are considerably higher than in modestly priced homes. In addition, if you plan to live in the home for a long time, a small reduction can be worthwhile.
8. Refinancing a home with less than 20% equity.
If you don’t have enough equity in your home, refinancing can increase your mortgage costs. If your equity value is less than 20%, your lender is likely to require you to pay private mortgage insurance (PMI). In the event of a default, this insurance protects the lender.
Conventional mortgages typically cost between 0.3% and 1.5% in PMI premiums. Payment for the premiums is added directly to your monthly bill. With that extra money added into your payment, you’ll lose out on any savings you might have obtained by locking in a low-interest rate.
9. Taking out too much equity at once.
Refinancing your mortgage allows you to borrow against the equity in your home. These funds can be used for home repairs, investments, or other significant purchases. Often, mortgage interest is tax-deductible on income-producing properties. Because of this, it makes them an attractive option for borrowing money.
However, the risk of taking out too much equity increases when homeowners take out too much equity. The value of your property might decrease and your mortgage repayments may increase to such an extent that you have little wiggle room if financial problems arise in the future.
Overall, if you want to cash out your home equity, be cautious when refinancing.
10. Don’t ignore your credit score.
There are usually minimum credit score guidelines set by lenders. Credit agencies such as Equifax, TransUnion, and Experian can provide you with your credit score. Your credit score could affect your ability to refinance or your interest rate if you’ve changed it since you got your first mortgage.
It’s great if your credit score has improved! However, if it went down by 100 points, it could affect your interest rate by half a point or more. Alternatively, it could prevent you from refinancing your home.
Keeping your bills current and reducing your outstanding debt will help you improve your credit score. Eventually, your credit score could qualify you for a better interest rate or a refi.
11. Buying a large item before your refinance closes.
While awaiting their refinance to close, many people purchase a car or furniture via credit while waiting to close on their refinance. It can result in a lower credit score or a higher debt-to-income ratio, which may make it difficult for you to qualify for the loan you want.
In other words, you could lose the loan if anything changes on your credit right before closing, as lenders typically pull your credit right before closing. If you’re waiting to close on your mortgage, avoid completing any credit transactions. It is possible to jeopardize your mortgage even if you pay off debt if your available cash is less than the amount the loan depends on. Between applying for a refinance and closing, you have to tread lightly.
12. Having to pay junk fees.
In addition to the regular closing costs, borrowers need to watch out for “junk fees” added to their mortgages. Sure, the cost of loan origination, application, and title fees is unavoidable and legitimate. But some lenders overcharge for things such as “document preparation” or credit reports.
As a general rule, junk fees are those that could be done by you or someone else for less.
Is it a good time to refinance my current mortgage?
Refinancing for a lower rate is great, but it’s just one piece of the puzzle. As an example, it wouldn’t make financial sense to refinance if it will take three years to recoup the costs after refinancing and you plan to move in two years.
You should also consider the loan term, as refinancing to a shorter term will help you build equity more quickly. Let’s say that you refinance your 30-year fixed-rate mortgage into a 30-year fixed-rate mortgage with 20 years left on it. In this case, you’re essentially extending the loan term by 10 years and paying more interest.
By dividing the total refinance cost by your monthly savings, you can determine whether refinancing is financially viable for you.
Am I required to refinance with my current lender?
Refinancing your mortgage can be done through your existing lender or through a new one.
Regardless, you should compare loan estimates from multiple lenders to ensure your interest rate is as low as possible.
Can I refinance for free?
Refinancing your mortgage is similar to applying for a new home loan. As such, expect closing costs should be included. These costs depend on your location and the amount of the loan. But, they should be about the same as what you paid at closing on your original loan.
In the event that you are unsure of your ability to pay for the costs of refinancing, ask your lender if they can cover some of the fees for you. A no-closing-cost refinance option may be available from your lender, which includes your closing costs in the total loan amount. In this case, you may have to make a slightly higher mortgage payment each month.
To gain a better understanding of all upfront costs, talk to your lender. You can also learn about different options for paying closing costs from a housing counselor. There are many programs offered by state and local housing commissions to assist buyers with closing costs. There might even be a grant available to help offset the cost of refinancing.
Freddie Mac offers a refinancing cost calculator that can help you estimate how much refinancing could cost.
Is it possible to refinance without 20% equity?
Short answer? Yes.
Refinancing may be feasible if you own your home for less than 20% and have a good credit score. In addition to the monthly mortgage payments, your lender will require that you pay private mortgage insurance (PMI).
How many times can I refinance my mortgage?
You can refinance your mortgage as many times as you like. In the case of conventional mortgages, you may be able to refinance immediately after your previous refinance closes.
You should keep in mind that refinancing isn’t free and that multiple credit inquiries can negatively impact your credit score. Take the time to weigh the cost of refinancing against the potential savings if you intend to refinance at a lower rate.