Refinancing can be a great way to save money or tap into your home’s equity. Before you jump in and get too excited, though, know the top mistakes that many borrowers make while refinancing. These tips can help you get the most of your refinancing process.
Refinancing When it Doesn’t Make Sense
Many borrowers jump at the chance to lower their interest rate, not giving it a second thought. While a lower interest rate does sound great and it can save you money, it is only beneficial in certain situations. Since refinancing costs money, you have to determine at what point you’ll break even. This means paying off the closing costs you had to pay to refinance and reaping the loan’s savings.
You can figure out your breakeven point with the following calculation:
Total closing costs/Total monthly savings = Break-even point
Your total monthly savings is the difference between your original mortgage payment and the new payment. If your break-even point is 36 months or less, it may make sense to refinance, but only if you’ll be in the home for a while afterward. Let’s say your break-even point was 24 months and you knew you would move in 36 months. It doesn’t make sense to pay all that money to refinance just to save a little money over 12 months. But if you knew you’d be in the home for another five years, for example, then it may be worth it.
Not Changing Your Term
When you refinance, you basically start your term over again. It’s also a chance to get a fresh start too. If you keep the same term, it’s like you start over from the beginning. For example, let’s say you have a loan now with a 30-year term and you’ve paid on it for five years. Interest rates drop so you want to refinance to save money. If you take another 30-year term, you just added five years to your loan. If instead, you take a 25-year term or less, you maintain the same progress, or put yourself in a better situation.
Before you take the lower term, make sure you can afford the payment. Lower terms have higher principal payments because you pay the loan off in a shorter amount of time. Don’t make the mistake of taking a payment that you can’t comfortably afford, as that will put you at risk of defaulting on your loan.
Not Checking Your Credit Score
Refinancing may not make sense if you don’t have the qualifications to get a good interest rate. Many people assume their credit is fine, but don’t check it. You can check your actual credit score through programs offered by banks and credit card companies. Most companies offer free access to your credit score. Watching that number can help you know where you stand. If it seems low, it may be time to pull your credit report to see what’s bringing your score down.
You can also pull your free credit reports from www.annualcreditreport.com. You have access to your credit report from each of the three bureaus annually. You can pull them all at once or one at a time. While they don’t include your credit score, your credit history is what makes up the score. If you notice late payments, high credit balances, or collection accounts, take care of the problems so that you can increase your score before you refinance.
Not Checking Your Home Value
Don’t just assume that your home value increased, that’s not how it works. Real estate values fluctuate all of the time. You can easily check your home’s value using an automated tool online. While it may not be extremely accurate, it will give you a ballpark estimate of your home’s value.
If you want something more concrete, look up the sale price of homes similar to yours in the area over the last six months. This will give you an average price that your home would sell for on the current market. This will be a good indication of the market value of your home.
Many people don’t even realize they are upside down on their loan or they assume they have more equity in the home than they have. Refinancing may not make sense if the home’s value isn’t as high as you thought. The higher your LTV is, the higher the interest rate most lenders will charge you.
Changing Jobs Right Before Applying
Just like when you applied for a purchase loan, lenders want a stable employment history. They like to see you at the same job for at least two years. If you recently changed jobs, it could be harder to find a willing lender. The only exception to this rule is if you changed jobs but stayed within the same industry. If you have a history of success within the industry, lenders may be more willing to accept the newer job change.
Using Your Current Lender for the Refinance
Your current lender may be a good resource for your refinance, but don’t assume they offer the best rate or terms. Shop around and get quotes from several lenders. See what is available to you. Some lenders may have different programs that help you get even more out of your refinance than your current lender can offer.
You may end up back with your current lender and that’s acceptable, but shop around first. You should know beyond a reasonable doubt that you are getting the best deal that is available to you today.
Before you refinance, make sure you have all of your ducks in a row. Don’t just refinance because you can. Do so because you’ll save money now as well as over the life of the loan. If the new loan has a lot of closing costs or a long break-even point, think of your other options before putting yourself in a tough financial position.