Refinancing your home can be a big decision. There are many factors to consider in deciding if it is the right time to conduct this transaction including the difference in interest rates, the closing costs and how long you plan to stay in your home. To make the best decision, you should avoid these top five mistakes homeowners make when refinancing their home.
1. Not Comparing Rates
When rates begin to drop, many run straight to their current lender for home loan refinancing. This can be a mistake. It is important to shop around whether you are buying your home or refinancing your home mortgage. A difference in just .25% can make a dramatic difference in your payments as well as the interest paid over the life of the loan. On a $200,000 loan for 30 years, a rate of 6.75% compared to 7.00%, can save you more than $12,000 in interest over that time period.
Another area that can save you money is closing costs. While rates may be fairly similar from lender to lender, closing costs can vary dramatically. With origination fees, points, documentation and processing fees easily equaling thousands of dollars, it pays to shop. The loan's stated APR can help you to compare rates from different lenders to find the best deal overall when you are considering home loan refinancing.
2. Not Obtaining Closing Costs in Writing
Lenders should give you a good faith estimate that breaks down all of your closing costs. This document should be in writing. If your lender agrees to give you a break on the origination fee, get it in writing. Anything that is written down will automatically override verbal agreements. You need to protect yourself and your money by making sure that all of the costs are laid out in writing. When you close, you don't want any surprises in this area.
3. Failing to Calculate the Breakeven Point
When you are comparing rates among lenders, it is important to calculate your breakeven point. The breakeven point is the time when you actually begin to save money. Home loan refinancing can be expensive with closing costs. Even if you are getting a better rate, it can take a while to breakeven because of the additional out of pocket expense you will have.
Let's assume your current mortgage of $150,000 is financed at 7.5% for thirty years resulting in a payment of $1,048.82. The home loan refinancing option you have is at 5.8% with $4,000 in closing costs. Your new payment will be $880.13, which is a savings of $168.69 per month. Divide your closing costs of $4,000 by your savings per month of $168.69 and you will see that it will take 24 months or two years to breakeven.
Why should you know when the breakeven point is? If you only plan to be in your house for another five years and your breakeven point occurs in year six, then home loan refinancing will not have been the best option no matter how much lower your interest rate may be. Calculating the breakeven point is usually the deciding figure for those who are unsure about whether or not to refinance.
4. Paying for an appraisal when your home's value is questionable
For some people, home loan refinancing is a way to eliminate PMI or private mortgage insurance. In order to eliminate PMI, your loan amount must be 80% or less of your home's value. If your home is valued at $120,000, then your loan amount must be less than $96,000. Many people rush out to refinance the minute they think they may have 20% equity.
But home loan refinancing can be an expensive venture, at least upfront. If your appraisal does not come back high enough, you are no better off than you were and you're actually worse now that you've paid a worthless appraisal fee. An appraisal can easily cost you several hundred dollars.
Before you order your appraisal, talk to the appraiser. Though they cannot guarantee an appraised value, they can usually give you a ballpark figure that can help you decide whether it is worth the risk to pursue it.
5. Refinancing for the same term with a lower payment
Interest rates have a tremendous impact on your payment amount. A two-point drop in rates can mean quite a bit of extra money in your pocket if you refinance. But before you jump into another thirty-year loan, consider home loan refinancing with a shorter term. Your payment may remain relatively unchanged, but you could pay off your home sooner and save thousands of dollars in interest.
Let's assume you have a $150,000 mortgage financed at 8% for thirty years with a payment of $1,100.65 per month. If you refinance the same loan amount at 6%, your payment will drop to $899.33 per month. But if you decide to refinance for fifteen years instead at a rate of 5.8%, your payment increases to $1,249.63 per month. But you will shave 15 years off of the repayment, which means a savings of more than $98,000 in interest. In a lot of places, that savings would buy a second house!
By avoiding these mistakes, you can come out on top when you are pursuing home loan refinancing. Being smart throughout the transaction can save you thousands of dollars!