Refinancing: Four Mistakes to Avoid

Refinancing gives you and your family options and flexibility, reducing bills and/or providing extra cash for necessary expenses. In most cases, refinancing involves obtaining a new first loan, usually on more favorable terms. This new loan pays off the remaining balance of your existing mortgage.

But borrowers must remember that refinancing is not a simple procedure. It can be a complicated and costly process, and homeowners can make many mistakes that cost big.

 

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Some big mistakes, and ways to avoid them:

Mistake: Refinancing without considering your future plans. How long do you intend to stay in your home? What can you afford in terms of monthly payments, and will that change? Many borrowers may plunge into the refinancing process without considering their individual situation. In this case, refinancing may not save money.

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Remedy: Stop and think. If you plan on moving in a few years, a long-term, fixed-interest plan may not be appropriate. Alternatively, if you intend on staying in your home, a highly variable and unpredictable adjustable-rate mortgage may not suit your needs. Do preliminary planning, and talk with your lender about details.

Mistake: Focusing on interest rates. When shopping for a new mortgage, interest rates are important. But don’t forget to look at the rest of the mortgage. What are the fees? What are the closing costs? Are there additional hidden costs? A low interest rate can save you money, but only if the rest of the mortgage is also appropriate for you.

Remedy: Decide on the details of the mortgage first. For example, perhaps you’ve decided a 30-year fixed-rate mortgage is ideal. Additionally, you’d like closing costs no higher than $1500. Within these parameters, you can compare interest rates and get a more accurate picture of which mortgage is the best.

Mistake: Overvaluing your home. The value of your home will determine the amount and terms of the new loan you are able to get. Since you originally bought your home, your home value has most likely increased. But the amount of this increase is a tricky number to come by. Added extra rooms? New flooring, carpeting, or patio? These additions may increase the value of your home, but don’t guess or assume. Lenders have very different formulas for what changes do to the value of a home. Also – be wary of using your property tax bill as the definitive value of your home. Often these numbers are thousands of dollars high or low.

Remedy: Use a licensed appraiser or appraisal service to determine the value of your home, in relation to the neighborhood, and taking into account any changes you’ve made.

Mistake: Skipping a break-even analysis. Without some legwork to determine if refinancing will truly save you money, you may be going through a lot of effort and expense with no reward.

Remedy: Determine if a loan works for you. The simple method of calculating your benefits is to take the total cost of doing the loan and divide it by the monthly cost savings to determine how long it will take to actually start saving. For example, if the cost of doing your loan was $1,500 and you realized savings of $75 per month, you would actually start saving money on the 21st month of the new loan. Now if you were planning to move within 2 years time, this might not work for you as an option. But if you plan to stay in the home for 3-5 or more years, then it becomes worthwhile to refinance.

Learn more about refinancing with our continuing article series, including the reasons to refinance, process and costs, and types.

Related Article: Refinancing: Five Reasons to Rework your Mortgage

Related Article: Refinancing: Know the Process, and the Closing Costs

Related Article: Refinancing: Three Common Types of Refinancings