Mortgage Refinancing has the potential to lower your payment and save you a lot of money. The problem is that common mortgage mistakes can quickly push you from the savings column into losing money. Here are several truths your broker won’t tell you about refinancing your home that will save you thousands of your hard-earned dollars.
Mortgage Closing Costs vs. Potential Savings
The goal of refinancing your home is to save money. You save by getting a lower monthly payment from today’s best refinance rates. You lose money by overpaying at closing. The more you pay closing on your new home loan for things like the loan origination fee or discount points the less benefit you’re getting from lowering your mortgage rate.
Makes sense right? The less you pay at closing the better off you’ll be in the long run. A good mortgage broker will explain how your break-even point is calculated and how long it will take you to get there. You can approximate your break-even point by adding up all of your out-of-pocket expenses and dividing the total you’re spending by the amount you’re saving every month. This will tell you (approximately) how long it’s going to take to break-even recouping your closing costs.
It’s worth saying that this calculation is only valid if you keep the same mortgage term length or choose a shorter one. Lengthening your term length, going from a 15-year to a 30-year mortgage for example, means you’ll never break even because of the finance costs you’re paying for those extra years.
What Your Mortgage Brokers Won’t Tell You
There are consequences to refinancing your home that you need to know about. The first consequence is how refinancing affects your home mortgage loan’s amortization. Mortgage amortization is the process of paying down your home loan over time that factors in the interest you’re paying. Home loans are front-loaded with interest meaning that from day one the majority of your payment gets pocketed by the lender as interest.
As a result you’re building very little equity in your home during the early years of your mortgage payments. This gradually reverses over time and you being building equity in your home and stuffing less cash in your lender’s pocket. Once consequence of refinancing your home is that the equity you’re building comes to a screeching halt after refinancing.
Your Mortgage Interest Tax Deduction
Another consequence of today’s low refinance rates is that come April the amount you’ll be able to deduct for mortgage interest is going to be painfully smaller. This could lead to a higher than anticipated tax liability or a smaller than expected tax refund.
It’s worth taking a look at how your tax liability will be affected and planning accordingly to avoid an unpleasant surprise next April.
Watch Out for Hidden Mortgage Fees
If your existing mortgage includes a prepayment penalty it could be expensive getting into a new home loan. Check your loan contract or call your current lender to find out if you’ll pay a penalty for refinancing and if and when that prepayment penalty expires.
Another example of a lender fee that drives up your cost with very little benefit is the discount point. If you spend any amount of time shopping for refinance rates you’ll find that lenders quote refinance rates that include discount points first.
Discount points are a fee you pay in exchange for lowering your mortgage rates. Typically one discount point is one percent of your loan amount and lowers your interest rate by .25%. Is it worth it? Mortgage refinance rates are at historically low levers so paying discount points doesn’t make sense for most homeowners. This fee raises your out-of-pocket expenses lengthening the amount of time it takes you to break even.
The average homeowner refinances every four or five years meaning if you haven’t broken even because you overpaid the loan origination fee or paid unnecessary discount points means you’re losing money no matter how low your refinance rates. It’s best to do your refinance rate shopping with quotes that do not include discount points.
How to Pay Less For Your Next Home Loan
Invest a little time shopping for the lowest refinance rates AND fees and you can pay significantly less at closing than your neighbors. Many of the fees you pay like the broker’s loan origination fee, application fee, processing fee, administrative fee or rate lock fee can be negotiated to pay less or not pay at all.
Some of these fees are simply junk fees that do nothing but drive up your out-of-pocket costs. Comparison shopping and careful negotiation can literally save you thousands of dollars.
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You can learn more about getting the best deal on your next home loan while avoiding lender junk fees and points by checking out my free Underground Mortgage Videos.
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Sorry, but the tax deduction one gets for paying interest on a mortgage is not a reason to delay refinancing. Say you are in a 30% tax bracket. Wouldn’t it be better to pay 30% of the saved interest to uncle Sam instead of continuing to pay all 100% to the mortgage company? Just a thought…
I’m not saying it’s a reason to delay refinancing…just that lower refinance rates means less of a deduction come tax time as a consequence.