Mortgage rates fell dramatically this year, but the decline has flattened out in recent months. This has left mortgage rates at incredibly low levels, especially when compared to where they began the year, when 30-year mortgage rates were nearly a full percentage point higher than they are now.
When mortgage rates are low, many homeowners find themselves considering the possibility of refinancing their mortgage to obtain a lower rate. While that seems pretty straightforward, there can be some pitfalls in the process, so some care needs to be taken if you decide to jump in.
8 common mortgage refinance mistakes
Prior to making the decision to refinance, it helps to understand some of the most common mortgage refinance mistakes. Doing so can ensure you get the savings and benefits desired.
1: Failing to do your real estate homework
You should get a general idea of your home's worth by checking home-valuation sites and speaking to a local real estate expert.
According to Allison Barnett of the Barnett Realty Group in Marietta, GA, "You should always strive to get a real-time market analysis from a local real estate professional." While home-valuation sites like Zillow can give you a very broad range, says Barnett, they also state that 'Zestimates' may carry a margin of error that's nearly 8% depending on your location. For a quick review, you can also get a working reckoning of your home's value by using HSH.com's Home Value Estimator.
You'll also want to do some local mortgage market research. You can get an reasonable idea of your potential mortgage rate, closing costs and new monthly payment without having anybody pull your credit or starting an application. It just takes a little bit of effort and some time.
Armed with the information you gather, you can visit HSH.com to view advertised mortgage rates from various lenders. Then, use a refinance calculator to estimate your new monthly mortgage payment.
2: Opening new credit accounts and running up debt
Lenders check your credit when you apply for a refinance, and most check it again just before settlement.
Making major purchases on credit or applying for new credit could lead to delays in the approval process, since it changes your credit profile. In the worst case, you could end up being declined for a mortgage refinance.
Every time you open a new credit account, your credit score may drop. Lower credit scores translate into higher mortgage rates, and that could reduce or even eliminate the value of your refinance.
While it's a difficult to estimate the number of FICO points you can lose due to newly-opened accounts and inquiries versus missed payments and maxed-out cards, a FICO study shows that, on average, people with the best credit scores (upper 700s) have not opened a new account in more than two years.
The bottom line? Although you may save $100 on a new TV by opening that store credit card you may also end up paying thousands more on your mortgage refinance.
3: Having a low credit score
Most lenders have minimum credit score guidelines. Even though you may heard that you can get an FHA loan with a credit score as low as 500, most lenders have their own set of "overlays" or add-ons on top of minimum underwriting requirements. These overlays can be whatever that particular lender or bank chooses.
Before you start a refinance, order your credit reports from Equifax, TransUnion and Experian. Consumers, by law, are entitled to one free credit report per year from each major bureau; you can get yours from AnnualCreditReport.com, the official government-authorized site.
This is important because, according to the Federal Trade Commission (FTC), 20 percent of credit reports contain wrong information. Five percent of those errors may result in the consumer receiving a higher mortgage interest rate.
Immediately report any errors. The bureau is required to remove any error or trade line it can't prove is yours.
How much does your credit score impact your ability to refinance? A lot, actually.
Let's say you have a 620 credit score and you're applying for a conventional loan. The difference between someone with a 620 score vs a 740 score could impact the interest rate by a full three-quarters of a percentage point, possibly more.
As an illustration, here's how a 0.75% interest rate difference could look based on a loan amount of $250,000 on a 30-year fixed mortgage.
- 740 score at 3.75% = $1,158 (Principal and Interest)
- 620 score at 4.5% = $1,267 (Principal and Interest)
In this scenario, that's a increase of $109 per month. This could be the difference in whether it would make sense for you to refinance, and that's not even taking into account the longer-term costs of total interest over time.
So does that mean that all hope is lost or that you shouldn't refinance? No.
In addition to cleaning up errors in your credit files, it may also be possible to purge errors with a credit software program called Rapid Rescore which can possibly raise your credit score by as much as 100 points in less than a week. If your credit score is low and you still want to refinance, ask your mortgage lender about this process.
4: Refinancing with your current lender without mortgage rate shopping
It can be convenient to simply refinance with your current lender. After all, they already have most of your information, and you might only need to provide updates to your documentation.
Why should you shop around for your mortgage refinance? Failing to compare rates can be costly over the long run.
For example, a common misconception is that your current lender is automatically going to give you a special deal or discount. That's not certain to be the case, so be sure to compare your existing lender's quote with others. You may or may not find other lenders who can offer a considerably lower rate as compared to what your current lender offers for a refinance, but you won't know unless you shop around.
Important note: Be sure to check with various lenders on the same day because mortgage rates can vary from day to day. Get all quotes in writing.
5: Forgetting to consider all mortgage refinance costs and fees
Can you end up paying more than you should when you refinance? Yes, if you aren't careful.
Lowering your monthly payment is a key goal for most homeowners looking to refinance. But it isn't necessarily the only consideration.
Look at all fees when comparing refinance offers. Run the numbers on different scenarios by changing the loan amount, and looking at the cost with and without upfront points.
Some mortgage lenders may offer no closing costs on refinancing to existing customers. But be on guard: Find out if the closing costs are being incorporated into the loan amount or if it causes the loan's rate to increase, which can raise the monthly mortgage payment.
You should carefully consider the amount of time you plan to stay in your house. If your goal is to move soon, or you're close to paying it off, a refinance may not make sense.
6: Not factoring your refinance breakeven point
Don't forget to calculate your breakeven point to see whether refinancing is truly worthwhile.
For example, let's say you're refinancing your mortgage and can save $100 per month, and your refinance closing costs are $4,000.
To calculate your refinance breakeven point, you'd divide $4,000 by $100 and you'll get 40. This means it would take 40 months (three years and four months) before you'll break even -- that is, before you actually begin to save any money.
While there can be reasons to do it, it's probably not worth it to refinance if you only expect to be in your home for a period long enough to only get your money back. After all, what would be the point? Unless breakeven is your goal, you'll need to be there longer than that breakeven point to see any savings.
In our example above, if you stayed in the home for four years, you would cover your costs and actually save $872 -- not bad, but hardly a huge windfall over that period of time. You might have been able to save as much by using the $4,000 to pay off higher-rate credit card debt or investing it instead. Regardless, run savings versus costs versus time frame scenarios; if you don't expect to remain in the home long enough to at least get to a breakeven point, refinancing -- or at least paying fees to refinance -- might not be a great idea.
7: Not locking in mortgage rates
Since mortgage rates can change often, make sure you and your lender are clear about when your rate is to be locked. Most mortgage rate locks are for 30, 45 or 60 days.
While some homeowners may be optimistic that mortgage rates may dip again, it's all but gambling really. Rates could drop, but waiting could also backfire on you and leave you saving less money, or make refinancing no longer beneficial.
It can take time to get a refinance approved, so be sure to submit the required documentation as soon as possible. If you drag your feet, you might have to pay a fee to extend the rate lock.
8: Overlooking the possibility that things could go wrong
The refinance process can be relatively straightforward for homeowners with great credit, strong equity positions, full income and asset documentation, and long-standing employment. However, due to new rules and regulations, as well as the fact that not every homeowner fits the perfect borrower mold, the refinance process can be bumpy for some.
If you haven't purchased a home or refinanced recently, you may be surprised by some of the new requirements regulators and lenders have in place.
Since 2009, there has been a considerable amount of new regulation for banks and lenders in order to prevent a repeat of the housing crisis. The rules were created by the Consumer Financial Protection Bureau (CFPB) and were mandated under the Dodd-Frank Act to ban many of the loose practices during the housing bubble. There are also new mortgage documentation requirements, rules for Qualified Mortgages and tests of your Ability-To-Repay capabilities.
Refinancing isn't the right move for everyone. However, it could also be a way to free up cash flow, pay down your mortgage more quickly, cancel PMI, or provide a number of other benefits.
Any major financial decision requires preparation -- and refinancing a home is no different. Educating yourself ahead of time can help you avoid common mortgage refinance mistakes and feel confident about making an informed decision.
This article was updated by Keith Gumbinger
Great stuff. I was going to try to close the deal today on a re-fi of my mortgage and learned a few choice strategies I would never have thought of! I'll definitely be using those!!