Refinancing can give you a second chance to get a better interest rate on your mortgage or to help you tap into your home’s equity. But there are plenty of mistakes that you can make with this process. Before you refinance your mortgage, learn the top blunders that you should avoid.
Resetting Your Loan Term
When you refinance, you can take out a loan term of 10, 15, 20, 25, or 30 years. The average homeowner opts for the 30-year because it has the lowest payment. But if your original loan was a 30-year loan and you made several years of payments on it already, you are basically starting over from scratch or resetting your term.
Rather than taking the 30-year term, you could opt for the 25-year or 20-year term, depending on how many years you’ve already paid on the loan. Even if you have a lower interest rate and/or payment, you add time to your loan, which costs you money. The longer you borrow the money, the more interest you pay. In the end, you could add years to your mortgage term, which defeats the purpose of the refinance.
Assuming Your Home is Worth More Than it Is
Some loan programs are only available to borrowers with low LTVs, especially cash-out refinances. If you assume your home is worth a certain value and base your new mortgage on that amount, you could be in for an unpleasant surprise. Some homeowners find out the hard way that they are upside down on their loan. In other words, they owe more on the mortgage than the home’s value. This pretty much wipes out any mortgage programs except HARP.
Other homeowners find out their home just isn’t worth as much as they thought, which leaves them with a higher LTV and limited abilities. If your appraised value is too low and you wanted to take cash out of the equity, you may lose the chance to refinance altogether. If you were just trying to get a lower rate, you may not get it because your LTV is higher than the lender assumed based on the information you provided.
Before you apply for the refinance, do your research. Use sites like Zillow or Redfin to get an estimated value of your home. This gives you a basis to start with when you determine if refinancing makes sense.
Refinancing When It’s Not Worth It
We are all guilty of jumping at the chance to save money, who wouldn’t? But sometimes refinancing to save a few dollars a month just doesn’t make sense. When you refinance your mortgage, you have to pay closing costs. These costs take away from the savings you would reap. If the closing costs are too high, you may never truly enjoy the savings.
In order to determine if refinancing makes sense or not, you need to know your break-even point. This is the point when you pay off the closing costs and start realizing the savings of the new loan. You only need two figures to calculate the break-even point – the total closing costs and the monthly savings.
You can then use the following equation:
Total closing costs/Monthly savings = Break-even point
If the break-even point is 3 years or less, it may make sense. If it’s any more than 3 years, you may want to give it careful thought. What are your plans for the future? Will you live in the home for a long time or will you leave soon? If you’ll move before you hit the break-even point, it may not make sense to refinance.
Not Shopping Around
It’s easy to use your current lender when you want to refinance. They already know you, which may mean that you have to provide less documentation. But what if your lender doesn’t offer the lowest interest rate? You won’t know unless you shop around with other lenders.
We suggest that you get rate quotes from at least three different lenders. This way you know what type of loans are available to you and what rates lenders will charge you. Some lenders have strict rules (lender overlays) beyond what the loan program requires. You’ll need to know these things to make sure that you get the loan that suits your needs the most.
Not Focusing on the APR
It’s easy to focus on the loan’s interest rate because you want the lowest monthly payment. But some attention should also be paid to the APR. This is the annualized interest rate for your loan based on the total cost of doing the loan. This includes the lender closing costs, giving you a better idea of what you are paying for the loan.
If you have three loans all with the same interest rate, but different APRs, it’s easy to tell which loans have more closing costs, therefore costing you more in the end. Your goal should be to find the loan with the lowest interest rate combined with the lowest closing costs in order to get the best deal.
Trying to Refinance With a Low Credit Score
You probably focused on your credit when you knew you wanted to buy a home because you wanted a loan. After you got it, though, did you still focus on your credit? Do you even know what your credit score is right now?
If your credit score is too low, refinancing might not make sense. Lenders base interest rates on how likely you are to default. If you are a high risk of default, a lender may increase your interest rate, which may defeat the purpose of refinancing.
Look closely at your credit. Determine if there are any areas you need to work on, such as bringing late payments current or paying some of your debts down. The higher your credit score is, the better your chances of securing a low-interest rate.
Avoiding these refinancing mistakes can make getting a loan much easier. Whether your goal is to save money or to tap into your home’s equity, you’ll need to be able to qualify for the loan. Also, don’t assume you have to refinance just because rates are lower. Make sure that it makes sense to do so or you could be wasting money.Click to See the Latest Mortgage Rates»