Published March 13, 2013
With interest rates low, refinancing your home could save you a bundle. However, navigating the refinancing market can be a bit tricky. If you want to get the best rates, here’s five common mistakes to avoid.
Know Your Home Value
Housing prices have declined quite a bit over the last five years, and while they have begun to rebound somewhat, many homeowners still have an unrealistic idea of what their homes are worth. If you go into a refinance thinking your home still commands top dollar, you might be shocked to find that a lender doesn’t place such a high price tag on it, which means you won’t get nearly the deal you hoped for. So make sure to research home prices in your neighborhood before visiting a lender.
Know Your Credit Score
Before you even start the refinancing process, make sure you know what sort of shape your credit is in. If your credit rating has taken a beating in the last few years, you could waste a lot of time on the refinancing process only to get an offer that’s actually worse than what you currently have, or simply be rejected outright by lenders. If your credit rating is decent, but not great, there are some things you can do to improve it in the months before you refinance. Don’t make any large purchases, like a new car. Pay down your credit cards and don’t take on any new ones. You can also check your credit report for errors, like debts that you have already paid off. Removing these mistakes will help get your finances in shape.
Interest Rate Isn’t Everything
There are many components to a home loan, and the interest rate is only one of them. Lowering your monthly payments may seem important, but refinancing might not be worth it if the new loan has restrictive terms, such as high penalties for late or early payments. Additionally, a new lender might want to get you on the hook for a 20- or 30-year loan, even if you only have a few years left on your current mortgage. Sure this will lower your monthly payment, but you’ll end up spending a lot more on interest over the life of the loan. So make sure to consider all the factors before you sign on the dotted line.
While many lenders will sell you on the low interest rates, they often downplay the cost of the refinancing itself. Between the legal fees, the home appraisal, the credit checks and other closing costs, you could be out thousands of dollars. Forking over the money to cover these costs makes sense if you can shave hundreds off of your monthly payments, but a refinance probably won’t be worth it if you’re lowering your rate by, say, half a percent. Figure out how long it will take to break even -- for the total monthly savings to be more than the closing costs -- and then decide whether you can live with that. And while there are lenders that promise refinancing deals with no closing costs, these often come with higher interest rates and strings attached so be wary of anyone offering a free lunch.
While you can often get a better upfront interest rate with an adjustable rate mortgage -- or ARM -- these rates can quickly and sharply shoot up, making one of these loans a pretty big gamble. ARMs aren’t always a bad idea -- for instance, a military family that expects to move around on a regular basis can benefit from the lower interest rate and be out before the rate increase kicks in. But if you plan on staying put in your home for a while, skip the ARM and just try to lock in a decent fixed-rate mortgage -- especially now that the rates are so low. You’ll save much more in the long run.