Mortgage rates have reached historic lows, with 30-year fixed-rate mortgages dipping below 3 percent for the first time in half a century. Consequently, the record-low refinance rates have enticed numerous homeowners to contemplate refinancing their existing home loans, whether to reduce monthly payments, expedite loan payoff, or tap into home equity.
However, before proceeding with a refinance, it is imperative to be aware of common pitfalls in the process and how to sidestep them. Here are key considerations:
Not shopping around:
To secure the lowest qualifying rate, it is crucial to invest time in shopping around and comparing rates from multiple lenders. Even when utilizing a broker, their options may be confined to specific lenders.
Focusing solely on the rate:
While the mortgage interest rate is a critical factor, it’s essential to recognize that multiple elements contribute to its determination, including mortgage points. A lender might present a lower rate to match or surpass a competitor’s offer but could offset it by charging more in the form of mortgage points. Additionally, your credit score significantly influences your rate, prompting the need to assess and potentially improve it before applying.
Whether contemplating a new home purchase or seeking to refinance, utilizing platforms like Credible can facilitate connections with experienced mortgage lenders. This enables comprehensive comparisons of accounts, encompassing rates, the value of points, and associated costs.
Overlooking Comprehensive Loan Costs:
When engaging in the process of refinancing an existing mortgage, bear in mind that this entails the creation of a new loan, inevitably incurring closing costs. Typically ranging from 2 to 6 percent of the loan amount, these closing costs are a crucial aspect to consider. The choice between covering these costs upfront or incorporating them into the new loan is pivotal. While the latter may seem attractive if cash is tight, it is essential to recognize that the additional amount will accrue interest over several years.
Prudent Utilization of Cash-Out Refinancing:
Opting for a cash-out refinance allows homeowners to access their home equity in cash form. This liquidity can serve various purposes, including debt consolidation, buying out a divorced spouse’s share in the home, financing renovations, and more. However, exercising caution is paramount, as using the funds for non-essential expenditures, such as vacations or extravagant living, may lead to adverse consequences.
Moreover, it is crucial to be aware of the limitations on the amount obtainable in a cash-out refinance—typically up to 80 percent of the home value. Prior consultation with lenders is advised to ascertain whether this option aligns with addressing the current financial objectives.
Neglecting Break-Even Point Calculation:
When pursuing a refinance to secure a lower interest rate, it becomes imperative to evaluate your anticipated duration of residence. This consideration is particularly crucial when covering closing costs out of pocket. For instance, if a reduced rate translates to a monthly saving of $120, with closing costs amounting to $4,560, the break-even point would be 38 months—indicating the duration required to recover the upfront costs through monthly savings.
Should your plans not involve staying in the residence for this duration, the refinance might result in a financial loss and might not be a judicious choice. Utilizing an online mortgage refinance calculator aids in determining the revised costs and comparing them against the initial expenses incurred in obtaining the loan.
Mindful Adjustment of Mortgage Duration:
After diligently making mortgage payments for five years, opting for a 25-year loan in lieu of a 30-year loan might prove more financially prudent. Opting for a longer repayment term, even with a reduced interest rate, could accrue higher interest charges over time, given the additional five years of payments.
Discarding Attempts to Time Mortgage Rates:
Indulging in the futile exercise of attempting to time mortgage rates can lead to missed opportunities. Similar to the unpredictability of timing the stock market, waiting for rates to decrease further might prove impractical, potentially causing missed advantageous refinancing opportunities. If the present aligns with your optimal conditions for refinancing, waiting may not be advisable.