One of the most common mortgage mistakes is neglecting to answer the question “Should I Refinance My Mortgage?” You might be surprised to find that the answer to your question is simply “No.” Sure refinance rates are near their lowest levels ever but that doesn’t always justify the expense. Here are five reasons to avoid a costly mistake from mortgage refinancing at the wrong time.
The Downside of Mortgage Refinancing
Most people get so hung up on the possibility of saving cash by refinancing that they don’t consider the downside of taking out a new home loan. The downside exists and can quickly turn low refinance rates into an expensive mistake.
Here are five reasons to avoid refinancing your home mortgage loan:
- You’re Not Long For Your Home
- Your Closing Costs Are Too Expensive
- Your Credit Score Isn’t What It Should Be
- You’re Choosing a Shorter Mortgage Term Length
- You’re Choosing a Longer Mortgage Term Length
It’s easy to say I’m comfortable in my home and am staying put. Next thing you know you’re whammied with a new job, promotion, or are getting married and it’s time to sell. Granted you can’t plan for situations like this but if the possibility of moving is on the horizon you might want to reconsider refinancing.
The reason you need to be staying put when refinancing is that it takes time to reach your break-even point for out-of-pocket expenses. Breaking even means you’ve reached the point where your savings eclipse the closing costs you paid getting a new home loan. Typical closing costs including your broker’s loan origination fee will run you 2-4% of your mortgage balance and this isn’t an expense to take lightly.
Suppose you’re refinancing $250,000 and saving .5 percent on your interest rate. If your payment is going down $80 a month but it’s costing $4,000 to close it’ll take you 50 months, just over four years before you’ll benefit from that lower payment. Sell or refinance again before that time is up and you’re losing money.
This mistake is along the same lines as the first reason. You might qualify for a ridiculously low refinance rate but have to pay a huge broker origination fee or discount points to get there. If you don’t have the cash on hand to pay your out-of-pocket expenses it might be tempting to accept higher refinance rates to have the lender pay the broker fee and closing costs for you.
Keep in mind anything that raises your out-of-pocket expenses or increases your refinance rates reduces your benefit from mortgage refinancing. If you roll these costs into your loan balance you’re reducing your home equity increasing your risk of being underwater. You need to decide if the deferred savings you’re getting are worth the cash it’s costing you to get there.
One of the most commonly overpaid mortgage expenses is the loan origination fee. This is paid to the person arranging your home loan and even if the lender pays it you could still be overpaying based on the increase in your interest rate. There are no free lunches when it comes to home loans so if a broker is telling you someone else is paying for you take a hard look at what you’re giving up in exchange.
If you’re finding the refinance rate quotes lenders are giving you are higher than what they are advertising the likely culprit is your credit score. If you’re sitting in the 600 range mortgage refinancing is simply not a good idea. It’s not that there aren’t lenders out there that will approve you, just that you won’t qualify for the attractive refinance rates offered to homeowners with higher credit scores.
You might be tempted just to bite the bullet and refinance with the interest rate you’re offered; however, investing a little time in improving your credit score will pay dividends well beyond your mortgage loan.
The first step to improving your credit score is to visit the website AnnualCreditReport.com. Congress passed a law stating the three credit reporting agencies (Experian, Equifax, and TransUnion) are required to give you a free credit report every year. You won’t get a credit score with these reports but will have the option to purchase one if you like.
Once you have your three credit reports check them carefully for errors. If you find mistakes you’ll need to dispute the error in writing with each credit bureau. Be sure and allow enough time for the correction to be reflected in your credit score before submitting your mortgage refinance application.
Refinance rates on 15 and even 10-year mortgages are at rock-bottom levels. You might be tempted to stuff what’s left of your 30-year mortgage into a 10 or 15-year refi. This will save you a ton of money in finance charges over that 30-year fixed home loan but it might not be the smartest move.
Paying a couple hundred dollars more every month might not seem like a big deal while you’re doing the paperwork but it can cause a real burden on an already stressed budget. If you hit a rough patch down the road you won’t have the ability to scale back your payment. Can you spare the cash in your monthly budget to afford that higher payment amount? (Now and how about later down the road?)
Remember that calculation from earlier for figuring out your break-even point on out-of-pocket expenses? That calculation is only valid if you choose a home loan with the same term length or go shorter. If you refinance with a longer term length it’s going to be impossible to break even recouping your closing costs due to higher financing of those extra years.
This is true of mortgage refinancing a 15-year home loan with a 30-year or even a 40-year mortgage. While it’s true that you’re getting a lower monthly payment by spreading your mortgage out over more time, you’re also increasing the total interest you’re paying over the duration of your mortgage.
Another problem with mortgage refinancing regardless of the term-length you choose is that since you’re getting a brand new home loan you’re resetting the clock your mortgage amortization schedule.
Amortization is the process of paying down your home loan. Because mortgage loans are front-loaded with interest in the early years the majority of your payment goes to paying the lender before paying down your principal balance. This gradually reverses over time and more of your payment goes to building equity. Once you refinance you reset this amortization clock and you’re back to stuffing cash in your lenders pockets.
Have You Decided Mortgage Refinancing Is The Right Move?
If you’ve decided to go forward with mortgage refinancing there are steps you can take to get the maximum benefit from today’s low refinance rates. The less you pay for the loan origination fee and other closing costs while avoiding discount points the sooner you’ll break even recouping those out-of-pocket expenses.
The mortgage fees you can negotiate to pay less are found on section 800 of your Good Faith Estimate. Here you’ll find your loan origination fee and lender junk fees like administrative and processing fees.
Negotiate these fees down or away and you’ll get the maximum benefit from a new home loan with today’s best mortgage lenders.
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