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With mortgage interest rates as low as they are right now, homeowners can save a lot of money by refinancing their home loan. But it's not as simple as finding a good interest rate and jumping on it - there's a lot more to it than that.
Please consider following 10 points when refinancing a home mortgage:
1 - Go shopping around
It's amazing how many borrowers simply go straight to their regular bank when they need a home loan or a refinance. Or how many simply check a few advertised rates and pick the lender offering the lowest one. Or who assume they have to refinance with their current lender.
When shopping for a mortgage refinance, it pays to check out the competition – big time. A difference of a mere one-eighth or one-quarter of a percentage point on your mortgage rate can mean a savings tens of thousands of dollars over the life of your loan.
Mortgage pricing can also be complicated, with many factors affecting the actual cost, so it pays to look carefully into rates, terms and fees offered by different lenders. Take your time and find your best deal.
2- Don't Decide on mortgage rate only
One of the biggest mistakes borrowers make is focusing solely on the interest rate when comparing mortgage lenders. A lot of factors go into mortgage pricing and a low refinance rate from one lender can actually cost more than a higher rate from someone else – a lot higher.
Closing costs can vary widely from lender to lender, and a seemingly low rate is sometimes used to disguise a loan with unusually high fees. Often, advertised rates are based on the borrower paying for discount points, a way of buying a lower rate.
Be sure to inquire about such things as the loan origination fees, points, credit reports and all other fees before applying for the loan. These aren't finalized until you receive your Good Faith Estimate once you apply, but any major changes at that point are a red flag that something's amiss.
3 - Do Lots of Saving
If you only get a small reduction in your interest rate, say half a percentage point, it's going to take you a long time to recover your closing costs. This is what's known as the break-even point – how long it takes your savings from refinancing to exceed what you paid to refinance.
For example, if you paid $5,000 in closing costs and you saved $100 a month by refinancing, your break-even point is 50 months – just over four years. But if you save only $50 a month, it will take you eight years to break even – and you might have sold the home and moved by then.
Most experts say you need to knock at least three-quarters or a full percent off your current rate to make refinancing worthwhile. High-end homes can justify a smaller rate reduction than more modestly priced ones, because the savings are much greater. A small reduction can also be worthwhile if you plan to stay in the home a long time.
4 - Don't Try to time mortgage rates
When interest rates are low, borrowers may watch daily changes in refinance rates, trying to jump in at the spot when rates are at their absolute lowest. But they often miss the boat completely and see rates go shooting back up again.
Timing mortgage interest rate is like trying to time the stock market - it's difficult even for savvy professionals. Look at it this way - rates are still lower than they've been for most of the past half century - getting greedy over fractions of a percent could translate to a lost opportunity.
5- Don't Refinance too often
With interest rates near record lows, many people who've already refinanced their mortgage are rushing to do so again, to lock in the lowest rate possible. While that's an attractive proposition, it's one that can lead you into trouble if you're not careful.
The problem is that refinancing costs money. To refinance a mortgage, you'll typically pay about 3-6 percent of the loan balance in closing costs, perhaps less on high-balance loans. So for refinancing to make sense, you need to save enough in interest to eventually cover the closing costs.
Some homeowners, in chasing ever-lower rates, make the mistake of refinancing too often. They pile up closing costs over time, so their loan balance keeps increasing - negating the benefits of refinancing in the first place.
6 - Do Review the Good Faith Estimate and other documentats
The Good Faith Estimate is a breakdown of the total cost of the mortgage, including the APR (interest rate) and all fees. Look it over carefully and make sure it matches up with what you were told before you applied - if there's a significant difference, consider looking elsewhere. Also, check over your final documents at closing to ensure they match the Good Faith Estimate, especially when it comes to fees - some unscrupulous lenders will try to tack on various nickel and dime fees at this point to generate extra income on the loan.
7- Don't Cash out too much home equity
Many people use a mortgage refinance as an opportunity to borrow against their home equity, taking out some cash for things like for home repairs, investments or a major purchase. Because the rates are low compared to other types of loans and mortgage interest is usually tax-deductible, it's an attractive way to borrow money.
The problem arises when homeowners take out too much equity that they leave themselves exposed should housing prices fall (as happened dramatically in recent years) or boost their mortgage payments so much that they have almost no margin for error if financial problems arise. Be conservative in taking any money out of your home and be sure to leave yourself a healthy cushion in home equity.
8 – Don't Stretch out your loan
Most homebuyers start out with a 30-year mortgage. By the time they're ready to refinance, they've been paying on it for a number of years. But if they refinance into a new 30-year mortgage, they're starting all over again.
Extending your mortgage like this can significantly reduce your monthly payments. After all, you're spreading out your remaining loan principle over a longer period. But it will likely cost you more in interest charges over the long run, even if you get a lower mortgage rate, because you're amortizing the loan balance over a longer time.
A better approach is to refinance into a new, shorter-term loan that closely matches the time left on your current mortgage. For example, if you've been paying on a 30-year mortgage for 7-8 years, you might refinance into a 20- or even a 15-year loan instead. Because shorter-term mortgages have lower rates, you can often shave several years off your mortgage with little or no increase in your monthly payment.
Extending your loan term can make sense if you're financially stressed and need to reduce monthly expenses, or if you're doing a debt consolidation loan or other type of cash-out refinance that increases the balance on your primary mortgage. Just be aware of the costs of doing so.
9 - Don't Agree to prepayment penalties
Though they aren't common, some mortgages will have buried in the fine print a prepayment penalty if you pay off the mortgage ahead of schedule – such as you would do if you sell the home or refinance again. Which you may want to do.
These often expire after a few years and are a common feature of "no-cost" refinances, where the lender waives the closing costs but makes up for it by charging a higher rate. The penalty ensures that lenders still get paid if borrowers sell or refinance before they can recover those costs through the higher rate.
In some cases, a lender will offer a slightly lower rate if the borrower will agree to a prepayment penalty. Borrowers with poor credit may also be required to accept a prepayment penalty in order to get their loan approved.
Aside from those, there's really no reason for a refinance to have a prepayment penalty, particularly one that still applies after more than 3-5 years.
10- Don't Pay junk fees
Just like with any other mortgage, borrowers need to be on the lookout for "junk fees" added on to the regular closing costs. While things like loan origination, application and title fees are unavoidable and legitimate, some lenders will add charges for things like "document preparation" or overcharge for obtaining credit reports or document delivery. The general rule is, if it's something you could do yourself or hire someone to do for less, there's a good chance it's a junk fee.