Mortgage rates are currently low, but you can’t expect them to stay that way forever. In fact, rates rose to 5% in 2022 for the first time since 2011. If you bought a home within the last five to seven years and you’ve built up equity, you might be thinking about refinancing. A refinance can lower your payments and save you money on interest, but it’s not always the right move. To know if it’s right for your financial goals, you may want to talk to a financial advisor. If you decide to move forward, you’ll want to avoid these five common mistakes that could cost you money.
Do you have questions about how refinancing can affect your long-term financial plan? Speak with a financial advisor today.
#1: Choosing a No Closing Costs Mortgage
When you refinance your mortgage, you’re basically taking out a new loan to replace the original one. That means you’re going to have to pay closing costs to finalize the paperwork. Closing costs typically run between 2% and 5% of the loan’s value. On a $200,000 loan, you’d be looking at anywhere from $4,000 to $10,000.
Homeowners have an out in the form of a no closing cost mortgage but there is a catch. To make up for the money they’re losing upfront, the lender may charge you a slightly higher interest rate. Over the life of the loan, that can end up making a refinance much more expensive.
Here’s an example to show how the cost breaks down. Let’s say you’ve got a choice between a $200,000 loan at a rate of 4% with closing costs of $6,000 or the same loan amount with no closing costs at a rate of 4.5%. That doesn’t seem like a huge difference but over a 30-year term, going with the second option can have you paying thousands of dollars more in interest.
#2: Lengthening the Loan Term
If one of your refinancing goals is to lower your payments, stretching out the loan term can lighten your financial burden each month. The only problem is that you’re going to end up paying substantially more in interest over the life of the loan.
If you take out a $200,000 loan at a rate of 4.5%, your payments could come to just over $1,000. After five years, you’d have paid more than $43,000 in interest and knocked almost $20,000 off the principal. Altogether, the loan would cost you over $164,000 in interest.
If you refinance the remaining $182,000 for another 30-year term at 4%, your payments would drop about $245 a month, but you’d end up paying more interest. And compared to the original loan terms, you’d save less than $2,000 when it’s all said and done.
#3: Refinancing With Less Than 20% Equity
Refinancing can increase your mortgage costs if you haven’t built up sufficient equity in your home. Generally, when you have less than 20% equity value the lender will require you to pay private mortgage insurance premiums. This insurance is a protection for the lender against the possibility of default.
For a conventional mortgage, you can expect to pay a PMI premium between 0.3% and 1.5% of the loan amount. The premiums are tacked directly on to your payment. Even if you’re able to lock in a low-interest rate, having that extra money added into the payment is going to eat away at any savings you’re seeing.
#4: Refinancing With Your Current Lender Without Shopping Around
A big mistake that a lot of people make is just refinancing with the same lender with whom they have their current mortgage. In fact, many lenders spend money marketing to their current customers to do just this. Not shopping around could mean a huge financial hit to a borrower who just accepts whatever deal is being marketed to them.
For example, choosing to go with the lender’s offer of refinancing at 4.5% might sound really nice. However, if the term is extended or if you could qualify for a 4.2% loan with another lender who wants to give you a special rate as a new customer, you’ll be missing out on a lot of money. It’s important to always shop around and get offers from multiple lenders to see what, on average, you might qualify for.
#5: Making a Large Purchase Before Your Refinance Closes
Many people have made the mistake of coming to terms for their refinance with their lender and while waiting to close they go out and buy a car or some furniture via credit. This becomes another hit to your credit, which could lower your score or make your debt-to-income ratio out of whack for the loan you’ve qualified for.
Lenders typically do a final credit pull right before closing and if anything has changed then you could be risking being denied for the loan and not closing at all. It’s a best practice not to complete any credit transactions while you wait to close on your mortgage. Even paying off debt could put your mortgage in jeopardy if your available cash is too far below what the loan is relying on. You have to tread lightly between applying to refinance and closing.
Refinancing isn’t something you want to jump into without running all the numbers first and making sure that you will come out ahead financially. It’s tempting to focus on just the interest rate, but while doing so, you could overlook some of the less obvious costs. For example, you should pay attention to the term of the new loan compared to how long your previous loan had left. Overall, it’s important to make sure it’s the right financial move for you.
Tips for Refinancing Your Mortgage
- When refinancing your house, you should shop around and you may want to speak to a financial advisor to ensure it’s a good move for your long-term goals. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- If you’re curious about what it might look like financially to refinance your current mortgage, you can run the numbers in our refinance calculator.
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