04 Mar 8 Dangers of Refinancing and How to Avoid Them
Refinancing your mortgage with our current low interest rates and today’s strong housing market can look very appealing, especially if you’re hoping to take cash out of the equity that’s built up since purchasing. There are a lot of upsides that make financial sense, depending on your personal goals and circumstances. However, if you’re not careful and get too fixated on the fluctuating interest rate or big cash payout, it could be easy to miss some unexpected dangers.
Before hiring an appraiser or mapping out a major home improvement project, let’s look at eight common pitfalls to avoid when refinancing:
Refinancing When it Doesn’t Make Sense
A good rule of thumb when refinancing is to make sure the interest rate on a new loan is at least one percent lower than your current mortgage. Otherwise, your savings could be minimal and not cover closing costs and fees. This especially holds true if you haven’t been in the home long enough to acquire much equity. Having less than 20% equity could result in having private mortgage insurance (PMI) added which may cancel out the savings.
If your debt-to-income ratio has increased since buying that may also make the timing problematic for lenders when you’re trying to qualify.
Don’t Disregard Your Credit Score
In order to take advantage of competitive rates, it’s a good idea to check the status of your credit score. A higher FICO (over 800 is considered excellent, 670 is average) will not only improve your chances for qualifying, but it will impact your monthly payment and interest paid over the life of the loan.
Be proactive by checking with one of the credit reporting agencies for any errors, keep paying on time, and try to maintain a debt ratio of below 30%. A lower credit rating doesn’t rule out refinancing, so check with your lender to see if it’s feasible and that it makes sense.
Don’t Skip the Homework
Your pre-refinancing assignment – if you choose to accept it – is to research your area home values to get an idea how much your home has gained in equity. Check out current interest rates and use online refinance calculators to get a ballpark figure for new mortgage terms and payments.
When shopping for lenders, think outside the big bank box and look at the variety of smaller institutions and private mortgage lenders out there. Working with someone you can trust can be just as important as the interest rate. Ask friends and family for suggestions and referrals.
Cashing Out Too Much
Resist temptation to leverage too much cash out of your home equity. While mortgage rates are typically lower than other loans and credit cards, don’t leave yourself vulnerable with higher monthly house payments and no cushion if values should fall. If you use the cash to pay down debt, don’t let your balances creep back up. If you’re investing in home improvement projects, make sure they’ll result in increasing your property’s value.
It’s also wise to avoid using refinance cash-outs on some big-ticket items like vehicles or vacations that have no return on investment.
Refinancing Too Often
While you’re certainly able to refinance more than once after purchasing your home, there’s a smart way to do it, and there’s refinancing too often. Some borrowers try to chase the lowest rate possible when they keep falling as they have for the past couple of years, replacing their mortgage more than once. But they’ll likely end up negating any savings attained from lower rates to inevitable closing costs and fees. Do your math and look ahead – not just at the immediate financial gratification.
Paying Too Long
It’s important to remember that when you refinance your current 30-year mortgage into another 30-year term, you’re starting all over again. The immediate savings on your monthly payments or a cash-out refi to consolidate debt can make financial sense, however the remaining principal can accumulate substantial interest in the long run.
If possible, it’s wiser to pay the mortgage down for a few years and then refinance into a shorter term of 15 or 20 years. If you’ve built up adequate equity and can garner a low interest rate, the increase in monthly payment could be negligible.
The “No Closing Costs” Loan
Beware of the lender offering a mortgage with “no cost” refinancing. There are always expenses involved for the transaction, including appraisal services and other administration fees. What the bank or lender typically does is roll those fees into the mortgage where they’ll cost even more money in the long run.
Speaking of closing costs, whether you pay them up front or folded into the loan, be sure to figure the break-even point ahead of time. This is the amount of time it will take you to pay on the new mortgage before recouping those expenses. It’s especially important if you don’t plan to stay in the home for very long.
Finally, the Fine Print
If you’re cautious in your decision to refinance, do the homework and crunch the numbers, then there’s the final potential pitfall to avoid in the paperwork. When you receive a good faith estimate in order to lock in a low interest rate, go over everything to see that it lines up with your initial discussion. When signing the final docs make sure there are no unexpected costs – often referred to as junk fees – and don’t agree to prepayment penalties.
If you successfully navigate the decision-making process and decide it’s worth it to refinance, our team at EnTrust Funding (ETF) is here to help. We understand that refinancing can sometimes be more daunting than the first mortgage, with many options and opportunities at hand. Give us a call today for expert guidance and support for your financial goals.