Like deciding when to go for a bunt or trick play in baseball, a home refinance is rife with opportunities but also miscalculations.
You might be considering a refi, because you want to pay less in interest. Perhaps you want to pull some money out of your house to put toward another expense. Or maybe you’re looking to reduce your term length. All good reasons to undertake a home refinance. But in an effort to land one of these benefits (and take advantage of the current state of the market, which can favor refinancers, since mortgage rates are at record lows), you could make a hasty decision that isn’t right for your own financial situation.
If you’re considering a home refinance now, take a look at these eight refinancing mistakes to avoid, so you can land a home run when you decide to proceed with a refi.
1. Don’t forget to do your homework.
Failing to do your research can be an early foundational mistake that could cost you throughout the entire refinancing process. To start off on the right foot, study up on the following:
- Your property value: It may have changed since you last looked or in the years since you signed up for your current mortgage.
- Mortgage rate: Get a general idea of current interest rates by browsing a variety of home-lender sites.
- Closing costs: Speak to a mortgage broker or a local real estate expert to get a ballpark idea of how much these charges will be.
- New payment amount: Use a refinance calculator, like ours, to see what your new monthly payment will be if you go through with a refinance.
2. Don’t assume you’re getting the best deal.
It’s not always the best idea to refinance with your existing lender out of convenience. Sure, they may have all of your paperwork and know your payment history, but lenders are often competitive. Just because they had the best rate last time doesn’t mean they will when it comes time to refinance. You could land a lower interest rate by borrowing from a different one.
When shopping around, remember to inquire about the annual percentage rate (APR), instead of just the interest rate. The APR is more accurate in reflecting your actual price tag since it incorporates all expenses and fees, such as closing costs.
3. Don’t fail to factor in all costs.
A mortgage refi can save you money in the long run, but going through the process can cost you some in the short-term. Be sure to consider all mortgage refinance expenses, which include:
- Credit fees
- Appraisal fees
- Points (which is an optional expense to lower the interest rate over the life of your loan)
- Insurance and taxes
- Escrow and title fees
- Lender fees
Additionally, it’s smart to review your Loan Estimate, which details the costs, features, and risks associated with your mortgage. Make sure you have enough set aside to cover your closing costs, which tend to add up to about 2 to 5% of your home value.
Many homeowners and borrowers are enticed by the idea of a “no-cost” loan. Some lenders offer this kind of loan, which typically means that the loan’s closing costs are wrapped up in the loan total rather than being charged upfront — leaving you to pay interest on those costs.
4. Don’t ignore your credit score.
Most lenders, including Ally Bank, have minimum credit score guidelines. You can check your credit score by ordering a report through a credit agency like Equifax, TransUnion, and Experian. If your credit score has changed since you applied for your first mortgage, it could affect your ability to refi and the interest rate you’re quoted.
If your credit score has increased, that’s good! But if it’s gone down 100 points, for example, it could impact the interest rate you’re able to get by half a point or more. Or worse, it could prevent you from qualifying for a home refinance.
To improve your credit score, pay your bills on time and work to reduce your outstanding debt. With time, your credit score could be in a position to secure you a better interest rate or qualify you for a refi.
Related: How Do Mortgage Rates Work
5. Don’t neglect to determine your refinance breakeven point.
Your financial health (which includes your credit score) can affect your refi interest rate a great deal. And the difference between your current interest and your refi rate, as well as your closing costs, can help determine whether refinancing makes financial sense or not. Which is why you need to determine your breakeven point.
Our refinance calculator can help you find that number. For example, if you’re going to save $125 a month in interest charges after refinancing, but closing costs are $5,000, you would need to stay in your home for at least 40 months to breakeven — that’s almost four years. (To calculate, divide $5,000 by $125.) If you don’t plan to stay in your home that long, it’s probably best to stick with your existing mortgage.
A good refi rule of thumb to remember: If there’s less than a 0.5% (half a percentage point, in mortgage speak) difference between your current interest rate and your refi rate, refinancing might not be worth it.
6. Don’t refinance too often or leverage too much home equity.
In an effort to always land the lowest rate, some borrowers make the mistake of refinancing excessively. Anytime you refinance a mortgage, you’ll typically pay 2 to 5% of the loan balance in closing costs. Refinance repeatedly, and these charges can add up over time, negating the benefits of refinancing — the amount you’ve saved in interest charges has gone toward closing fees.
On the other hand, a lot of homeowners leverage their home equity to pay for something else unreasonably. Mortgage interest rates are often much lower than other types of loans, making it a desirable way to borrow funds. But the difficulty comes if borrowers take out too much equity compared to the value of their home.
This over-leveraging of home value could leave you susceptible should housing prices fall. It could also increase your mortgage payments, depending on how much equity you have in your home. Also know that you’ll need to meet a certain net tangible benefit, which could vary by lender. Without meeting this requirement, the lender will likely deny you the refinance.
7. Don’t overreach.
We all want to save money and streamline our monthly finances. A lower monthly payment can add up to significant savings in the long-term. A sweet prospect indeed, but that doesn’t mean you should overextend yourself in the short-term to get there.
A home refinance requires cash on hand to cover all of the fees and closing costs. (As we mentioned, you can roll these into the balance of your new loan, but you’ll pay interest on that amount, costing you even more.) If you have to take cash out of your emergency fund or take a cash advance on your credit card to pay for these expenses, a refi might not be a great idea for you. Putting yourself into debt to theoretically save in the long run is a zero-sum game. Avoid opening new credit accounts and running up debt or zeroing out your savings to make the refinance process happen.
8. Don’t assume that rates and fees are non-negotiable.
If you have stellar credit and have done your homework by comparison shopping, you might be able to secure a better interest rate, lower fees, or both from your chosen lender. Get quotes from several lenders and ask your preferred one if they can match another offer.
By avoiding these common pitfalls, you’ll have the homefield advantage when considering a home refinance — and could slide into your existing home with savings.
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