Are you thinking of refinancing your home mortgage but afraid you'll screw it up? While there are a number of common mistakes people make, take solace in the fact that these slip-ups can be avoided.
First things first, you want to make sure that refinancing is right for you, says Fred Arnold, a loan professional and treasurer of the National Association of Mortgage Brokers (NAMB).
"It has to make financial sense. It has to save you money and work for your future financial goals," says Arnold. For example, you want to ensure that with the new loan's terms, you'll save money. Another thing to consider is how long you plan to stay in your home. According to Arnold, to cover the cost of refinancing, it'll need to be about two years or more.
So if refinancing sounds like a good option for you, read on for four common mistakes and advice for avoiding them.
Mistake #1: Failing to Shop Lenders
America is the land of freedom. And freedom usually means choice.
So when it comes to a decision as big as refinancing your home mortgage, the last thing you want to do is give up that choice by going with the first loan you're offered. After all, you could be talking about hundreds of thousands of dollars.
That said, don't expect a huge amount of options when it comes to comparing interest rates.
"Rates right now are phenomenally low," says NAMB President Don Frommeyer. "But there's not a lot of difference between lenders. Maybe an eighth of a point. "But that eighth of a point (or .15 percent) could add up over time.
Below is one instance that shows why it's still important to shop. Our example, which we plugged into mortgagecalculator.com, assumes a person is borrowing $300,000.
|Loan A||Loan B|
|Interest Rate||3.75 percent||3.90 percent|
|Monthly Loan Payment||$1,389.35||$1,415.00|
|Total Payoff of Loan in 30 Years||$500,164.84||$509,401.66|
|Total Interest Paid in 30 Years||$200,165.84||$209,401.66|
Difference in Interest paid: Loan B is $9,235.82 more expensive.
In our book, that's over 9,000 reasons to shop around for the best rate, even if it is just an eighth of a point.
Mistake #2: Not Factoring in Costs and Fees
Refinancing is a service that costs money. And like anything that costs money, you need to factor in the price to see if the assumed savings outweighs that expense.
"The secret to refinancing is to look at it from the standpoint of, 'How much is it going to cost me and how long until I can recoup those costs through the monthly savings?'" says Frommeyer.
Regarding how much it will cost to refinance, here are some median or estimated costs, according to the Federal Reserve Board - the main governing body of the Federal Reserve System, which oversees national monetary policy and the banks:
- Application fee: $365
- Appraisal fee: $292
- Lender-required home inspection fees: $330 to $500
- Loan origination fee: $2,537 (with a 10 percent down payment)
- Points: 0 to 3 percent of the loan amount
And depending on your specific situation or location, there could be other possible costs, too.
As a rule of thumb, you want to reduce your interest rate by at least one percent, according to Frommeyer. In most scenarios, this could save you back the expense of the fees in under two years.
For instance, if your closing costs were $3,000, but you save $150 per month on your mortgage payment, then you will pay for the costs in 20 months.
Mistake #3: Avoiding a Short-Term Loan
In addition to choosing a lender, you have a choice when it comes to the length of your loan.
What are the options? The two most common loans are 30-year and 15-year terms, meaning that you will pay off your loan in a total of 30 years or 15 years.
As you might expect, all other things being equal (like your credit and the amount being borrowed), the 15-year loan will result in a higher monthly payment, according to Arnold. Since you're paying off the principal amount (the amount you are borrowing) sooner, the amount of each individual payment must be more.
For this reason, even though you are saving money over the long run, make sure you can afford to pay more each month.
But there's also good news for a 15-year loan. According to Arnold, because the term is half the amount of time, interest doesn't accumulate as long - therefore, you pay far less over the life of the loan. Add that the interest rate is typically half a percent lower than a 30-year loan, and the savings could really add up, Arnold says.
How much? The best illustration is with another example:
If you borrowed $250,000 for 30 years at 4.5 percent, you would pay $206,016.78 in interest over the life of the loan. And your monthly payment would be $1,266.71.
However, if you borrowed $250,000 at 4 percent for just 15 years, your monthly payments would rise to $1,849.22, but the total amount of interest would be only $82,859.57.
Your total savings with a 15-year loan: $123,157.21
Mistake #4: Delaying Locking in Your Interest Rate
When you make a financial decision as big as refinancing your mortgage, it's expected that a certain amount of apprehension can be involved. And sometimes that manifests itself into not being able to "pull the trigger" on locking in your interest rate.
And just what does locking in your rate mean? Basically, it's when you and the lender agree on the terms of your loan, according to Frommeyer. These terms include the closing costs and the interest rate at which you will borrow money.
"Getting a rate lock confirmation is absolutely important," says Frommeyer. "Mortgage brokers always get confirmation from the customer that they want to lock the loan, and once we get that locked, we make sure we can give the customer a copy."
The upside? Even if interest rates go up after you've locked in your rate, the bank can't charge you that higher rate. And this is even better news with a 30-year fixed rate standing at a low 3.60 percent as of Sept. 5, 2012, according to Mortgage News Daily, an organization that provides housing news and analysis.
So can you guess the potential downside? That's right. If rates go down, you've agreed to pay the higher rate. This is why it's important to be comfortable with the rate you choose and then lock it, according to Frommeyer.
"I tell my clients to decide on a rate that they will be happy with no matter what happens. Then be comfortable with that decision after you lock it, knowing that you got what you wanted," says Frommeyer.
- interest rates