Low interest rates do not necessarily mean owners will save on their mortgages.
When interest rates are low, leading many owners to refinance before assessing the true consequences of their actions. A mortgage refinancing can benefit some homeowners, especially if they intend to stay in their homes for the long term or whether they can significantly reduce their interest rates. Sometimes, however, a mortgage refinance may be the wrong choice.
“People often make bad decisions because of what I call” the envy of interest rates “around the coffee table,” says AW Pickel III, CEO of Financial LeaderOne in Overland Park, Kansas “They jump to refinance just so they can tell their neighbors they got a lower rate.”
Here are five of the biggest mistakes homeowners make when refinancing.
Not comparing the actual rate
“Borrowers should shop around for a mortgage by comparing the APR (annual rate) of each loan, rather than the interest rate quoted,” said Gregg Busch, vice president of First Savings Mortgage Corp. in McLean, Va. “You must look at the actual cost of the loan and compare it to your current APR to ensure that you will really save a half point or more on the new loan. ”
Busch points out that many owners today are finding that their home is worth less than they assumed when they have an appreciation.
“Fannie Mae and Freddie Mac have added fees on loans with high loan to value, so borrowers need to reassess the rates and fees before they decide to refinance,” said Busch.
Borrowers who have little or no action may be eligible for refinancing under Home by the Government of affordable refinancing program, or harp, available to those with an existing mortgage owner or guaranteed by Fannie Mae or Freddie Mac.
“The beauty of the HARP program is that it does not require an appraisal, so if you think you are underwater on your loan, this could be a good option,” said Busch. “Just make sure to compare rates and fees to see if the new loan is worth the cost.”
Choosing the Wrong Loan
Pickel said the first step when deciding to refinance is to establish a clear objective.
“If you think you can lose your job, but you have a moment, your focus should be to reduce your overall payments regardless of the length of the loan,” says Pickel. “If you want to be debt free by some years, then you need to find a loan that meets that goal.”
Pickel said that sometimes, even with a lower interest rate, you could end up making higher monthly payments due to packing in closing costs has increased the size of your mortgage.
Each borrower must look at the cost of refinancing and the financial benefits before choosing a loan, said Busch. Forget that some borrowers to refinance into another 30-year mortgage can add years of payments, especially if they have paid on the loan during a long time.
“A ARM 10 / 1 (variable-rate mortgage) or a 10-year fixed rate loan can sometimes be a better choice depending on the individual circumstances of the borrower,” said Busch.
Not Shopping Around
While many borrowers to compare loan offers from more than one lender, they can also shop for title services and save hundreds or sometimes thousands of dollars on their loan.
“Check at least three lenders and at least three companies before choosing a title,” said Busch. “It can be an advantage to go to the Management Authority that manages your loan the same now, because they may require less documentation, but I recommend also searched at least one other direct lender to compare rates and expense. ”
Ask the company as a reissue rate on title insurance own your vehicle – Busch believes that this can save up to 35 percent on premiums.
When refinancing you should not
Charles A. Myers, president and CEO of Home Loan in Jackson, Mississippi, said refinancing can be a mistake if you do not plan to stay in your home for many years.
“One client wanted to refinance to improve his property and rent it, but it would have ended up with a larger mortgage and then need a different loan because the property is no longer the principal residence,” says Myers. “The key is to ensure that the refinancing has a net tangible benefit to the owner.”
Borrowers must decide how long they intend to stay in the property and determine the break-even as economies outweigh the costs before deciding to refinance, said Myers.
Does not follow the Borrower responsibilities
Owners should rely on a lender to refinance, but they have obligations of their own that they are not met, could derail the mortgage refinancing. Borrowers must have good credit to refinance with most lenders require a credit score of 640 and above even for a loan insured by the Federal Housing Administration, said Myers.
Lenders can check credit borrowers again just before closing, if you need to maintain good credit and avoid a new debt, even after the refi was approved.
“Check the lock-in date to the interest rate on your new loan to make sure you can close before the rate expires,” said Busch. “Be sure to turn in all your documents as soon as it is required, because a delay could mean that your date should be postponed.”
One important thing to determine is your breakeven point — how long it’ll take to recoup your costs.
Refinancing applications represented approximately 80% of all mortgage loan applications in September 2010, according to the Mortgage Bankers Association (MBA), in part because extremely low mortgage interest rates encourage homeowners to restructure their finances. But whether or not a mortgage refinance is right for you depends more on individual circumstances than this week’s mortgage interest rates. Here are a few considerations to think about before applying for a home refinance:
1. Home Equity
The first qualification you will need in order to refinance is equity in your home. Dropping home values across the country have left many Americans “underwater”, owing more to their mortgage lender than their home’s current market value. Other homeowners have low equity. Refinancing with little or no equity is not always possible with conventional lenders, but some government programs are available. The best way to find out if you qualify for a particular program is to visit a lender and discuss your individual needs. Homeowners with at least 10-15% equity will have an easier time qualifying for a new loan.
2. Credit Score
Lenders have tightened their standards for loan approvals in recent years, so some consumers may be surprised that even with good credit they will not always qualify for the lowest interest rates. Typically, lenders want to see a credit score of at least 720 or higher in order to qualify for the lowest mortgage interest rates. Borrowers with lower scores may still obtain a new loan, but the interest rates or fees they pay may be higher.
3. Debt-to-Income Ratio
If you already have a mortgage loan, you may assume that you can easily get a new one. But lenders have not only raised the bar for credit scores, they have also become stricter with debt-to-income ratios. While some factors such as a high income, a long and stable job history or substantial savings may help you qualify for a loan, lenders usually want to keep the monthly housing payments under a maximum of 28% to 31% of your gross monthly income. Overall debt-to-income should be 36% or less, although with some additional positive factors some lenders will go above 40%. You may want to pay off some debt before refinancing in order to qualify.
4. Refinancing Costs
A home refinance usually costs between 3% and 5% of the loan amount, but borrowers can find several ways to reduce the costs or wrap them into the loan. If you have enough equity, you can roll the costs into your new loan, increasing the principal. Some lenders offer a “no-cost” refinance, which usually means that you will pay a slightly higher interest rate to cover the closing costs. Don’t forget to negotiate and shop around, since some refinancing fees can be paid by the lender or reduced.
5. Rates vs. Term
While many borrowers focus on the interest rate, it is important to establish your goals when refinancing to determine which mortgage product meets your needs. If your goal is to reduce your monthly payments as much as possible, you will want a loan with the lowest interest rate for the longest term. If you want to pay less interest over the length of the loan, look for the lowest interest rate at the shortest term. Borrowers who want to pay off their loan as fast as possible should look for a mortgage with the shortest term at payments they can afford.
When you compare various mortgage loan offers, make sure you look at both the interest rates and the points. Points, equal to 1% of the loan amount, are often paid to bring down the interest rate. Be sure to calculate how much you will pay in points with each loan, since these will be paid at the closing or wrapped into the principal of your new loan.
7. Breakeven Point
An important calculation in the decision to refinance is the breakeven point, the point at which the costs of refinancing have been covered by your monthly savings. After that point, your monthly savings are completely yours. For example, if your refinance costs you $2,000 and you are saving $100 per month over your previous loan, it will take 20 months to recoup your costs. If you intend to move or sell your home within two years, a refinance under this scenario may not make sense.
8. Private Mortgage Insurance (PMI)
Homeowners who have less than 20% equity in their home when they refinance will be required to pay PMI. If you are already paying PMI under your current loan, this will not make a big difference to you. But some homeowners who own homes that have decreased in value since the purchase date may discover that when they refinance they will need to start paying PMI for the first time. The reduced payments due to a refinance may not be low enough to offset the additional cost of PMI. A lender can quickly calculate whether you will need to pay PMI and the impact on your housing payments.
Many consumers rely on their mortgage interest deduction to reduce their federal income tax bill. If you refinance and begin paying less in interest, your tax deduction will be lower, although few people view that as a reason to avoid refinancing. Points paid during a refinance can be deducted over the life of the new mortgage loan.