It seems like a slam dunk. Refinance your mortgage to a lower interest rate. Reap the savings in your monthly budget and for the long-term.
But before you get caught up in the idea of refinancing a home and laughing all the way to the bank, take a step back.
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Refinancing isn’t the right move for everyone. And even if you think refinancing a home is the best thing to do, you could end up regretting the choice to refinance if you aren’t careful about how you do it. That’s because refinancing is a big financial deal — almost as big as buying a home in the first place.
So, before you start the refinancing process, know what could trip you up, and prepare to avoid the following pitfalls:
1. Not knowing where you stand
One of the first things to realize about refinancing a home is that it is a new mortgage. Your new home loan replaces your old mortgage. You’ll jump through many of the same hoops you did the first time around. That includes going through a credit check and income verification.
Additionally, depending on the refinance, you might need an appraisal as well. Before you apply for a refinance, look at your circumstances. Do you have a stable income? Has your home increased in value? How much have you paid on your original mortgage?
Real estate expert Brian Davis recommended improving your credit as needed before speaking with a mortgage lender. Davis is an expert with SparkRental, a website for landlords, and a columnist for popular real estate website Bigger Pockets. “The better your credit,” Davis said, “the better your options for financing will be.”
Be honest about where you stand. If your credit has dropped since you got your original mortgage, there’s a chance you might not qualify for your best rate. Besides, if you haven’t built enough equity in your home by paying down your debt or seeing an increase in your home’s market value, you might not even be eligible for refinancing with some lenders.
Don’t apply for refinancing until you’ve done your homework and you have a pretty good idea of where you stand.
2. Adjusting your finances in any way
It might be tempting to get an auto loan or to use your credit card to make a large purchase (and possibly even get points). However, making changes to your finances — especially when it comes to debt — is a quick way to derail your attempt at refinancing a home.
“Don’t change a thing,” said Denis Kelly, national vice president at Sprout Mortgage. “If you’re considering refinancing your mortgage, hold off on taking out other loans, opening or closing credit card accounts, changing jobs or your career, or anything that makes you appear higher-risk to your mortgage lender.”
Kelly pointed out that lenders look at how much you owe compared to your monthly income. Taking on more debt before refinancing can skew that ratio and make you appear less able to meet your new home loan obligations.
Kelly also warned against making large, one-time deposits to your bank account. Anything out of the ordinary can trip up your refinancing application. “The goal is to show a consistent financial picture,” he said. “If you want to do anything different, wait until your refinance is complete.”
3. Not toting up all the costs of refinancing a home
Just because you can get a lower mortgage interest rate doesn’t mean refinancing is necessarily the best deal for you. Davis, who spent six years on the financing side of the industry, said many mortgage lenders gloss over the costs of refinancing. “Beyond closing costs, refinancing also prolongs your debt and resets your amortization schedule,” he said.
Carla Gervais, the director of sales and operations with The Mortgage Advisors, a mortgage brokerage, agreed about the importance of running a cost analysis when refinancing a home. “Depending on the terms of your new refinanced mortgage, you might not break even for two years or more,” she said. “Know exactly what you are signing up for.”
Gervais said closing costs could average about 1.5 percent of a mortgage. Refinancing $180,000 means $2,700 in closing costs.
And don’t trust a lender claiming “no closing costs,” according to Davis. “There’s no such thing,” he said. “Lenders always find a way to earn fees, including costs like appraisal.”
Before you jump in, use a mortgage refinancing calculator to play with the numbers. A longer loan term, plus closing costs, could end up costing you more, depending on the situation. The longer you plan to stay in your refinanced house, though, the better the chances you’ll come out ahead. Know your breakeven point before signing the refinancing papers.
4. Failure to shop around and negotiate
If you’re comfortable with your current mortgage lender, it seems like it might be easier to just refinance without checking out other home loan sources. But if you just assume your current lender is offering you the best deal and don’t look around for refinancing opportunities, you might miss out on a better mortgage rate and other terms.
It’s not just about shopping around, though. You don’t have to accept the fees and rates offered by mortgage lenders. Once you begin comparing your various possibilities, you’ll have the leverage to demand better terms. “Shop around, get a slew of quotes, and pit the best options against each other,” said Davis.
5. Not locking in your mortgage rate
Finally, don’t assume that just because you’ve received a rate quote, you’re done. Mortgage rates can change quickly, and the rate you’re offered at the beginning of the process might not be the same as when the refinance is actually complete.
Fill out the paperwork to lock in your rate, so you don’t have to worry if rates head higher in the 30 to 60 days it can take for everything to finalize, suggested Casey Fleming, a long-time mortgage industry insider and author of The Loan Guide.
On the other hand, ask your mortgage lender if you can sign an agreement that allows for a lower rate, just in case mortgage rates drop. “Some lenders will agree to honor a lower rate in the future, even if they agree to keep from raising your rate if the market rates head higher,” said Fleming. “Just make sure the paperwork reflects that situation.”
Davis also warned against choosing an adjustable-rate mortgage (ARM) for your refinance. The Federal Reserve “wants to gradually raise rates over time, so if you don’t lock in with a fixed-rate, you could be in for a nasty surprise later,” he said.
Prepare for your refinance
Any major financial decision requires preparation — and refinancing a home is no different. Carefully consider whether refinancing is the right move for you, based on your financial situation.
Once you know it’s what you want to do, and it makes sense for your money, proceed with caution, educating yourself ahead of time so you are ready to complete the process with minimal fuss.