mortgage

5 steps to a successful refinance

Highlights
  • Finding the right lender crucial to keeping closing costs down.
  • Documentation of finances more important than it used to be.
  • Many borrowers limited to FHA-backed mortgages.

As mortgage rates dip to multiyear lows, many homeowners wonder if a new loan could save them money.

Others fear the rate on their adjustable-rate mortgages might move up significantly and crave the certainty of a fixed-rate loan.

Whatever the reasons, mortgage refinance activity has exploded in recent weeks. Perhaps you are among the millions planning to swap your old mortgage for something better.

If so, there are five crucial steps you need to follow to guarantee a successful refinance:

Road to refinance
There are five steps you must take to help guarantee a successful refinance.

Step 1: Weigh the pros and cons 

A refinance allows you to take out a new loan that pays off your current mortgage. Although you are then obligated to make payments on the new loan, your costs typically are lower after refinancing.

A new mortgage with a rate that's just a half-percent lower may save you hundreds of dollars each month.

Refinancing allows you to enjoy a do-over if you didn't get the mortgage process right the first time. It sounds simple: refinance and save.

But it's important to look beyond the immediate monthly savings, warns Mike Dubis, a Certified Financial Planner in Madison, Wis.

"Consider how much interest you'll be paying with a new loan in total, compared to what you've already paid with your old loan," he says.

For example, if you've had your mortgage for 10 years, you've paid mostly interest thus far. Lenders structure loans so that borrowers pay off interest charges in the first years. After that, more of the monthly payment reduces the principal owed.

"Even though your monthly payment is lower, you might be paying more interest over the life of the new loan than you've got left to pay on your old mortgage," Dubis says. "Besides that, if you take out another 30-year mortgage, you might be still paying that thing when you're retired."

For those who want to refinance yet still hope they'll someday own their home free and clear, lending companies often provide loans with terms matching the years left on your old mortgage. Or they offer terms of 10, 15, 20 and 30 years.

Rates often -- though not always -- are lower on loans with shorter terms. However, monthly payments on these loans tend to be higher. The lure of low monthly payments is the reason many homeowners keep selecting new 30-year loans.

Many middle-class families live paycheck to paycheck, and a new 30-year fixed-rate loan with more economical payments may be their only realistic option, says Margot Saunders, counsel to the Boston-based National Consumer Law Center.

"It gives them some flexibility," she says. "They'll have a little extra money each month."

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In some cases, it makes financial sense to refinance. In other situations, it does not. How do you know if refinancing is the right choice?

It's often said that if you can recoup the cost of a refinance in a year, it's worth doing. But that old maxim is too simplistic and ignores a host of other important considerations.

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