Coveting thy neighbor's rate
When interest rates are low, plenty of homeowners rush to refinance before evaluating the true consequences of their actions. A mortgage refinance can benefit some homeowners, particularly if they intend to stay in their home for the long term or if they can significantly reduce their interest rate. Sometimes, though, a mortgage refinance can be the wrong move.
"People often make poor decisions because of what I call 'interest rate envy' around the coffee table," says A.W. Pickel III, CEO of LeaderOne Financial in Overland Park, Kan. "They jump at refinancing just so they can say to their neighbors that they got a lower rate."
Here are five of the worst mistakes homeowners make when refinancing.
Not comparing the real rate
"Borrowers should shop around for a mortgage by comparing the APR (annual percentage rate) of each loan rather than the quoted interest rate," says Gregg Busch, vice president of First Savings Mortgage Corp. in McLean, Va. "You need to look at the true cost of the loan and compare it to your current APR to make sure you will really be saving one-half point or more on the new loan."
Busch points out that a lot of homeowners today find out that their home is worth less than they assumed when they have an appraisal.
"Fannie Mae and Freddie Mac have added fees on loans with a high loan-to-value, so borrowers need to re-evaluate the rate and fees before they decide to refinance," Busch says.
Borrowers who have little or no equity may qualify for a refinance under the government's Home Affordable Refinance Program, or HARP, available to those with a current mortgage owned or guaranteed by Fannie Mae or Freddie Mac.
"The beauty of the HARP program is that it does not require an appraisal, so if you suspect you are underwater on your loan, this could be a good option," says Busch. "Just make sure you compare the rate and fees to see if the new loan is worth the cost."
Choosing the wrong loan
Pickel says the first step when deciding to refinance is to establish a clear objective.
"If you think you may lose your job but you have one now, your focus should be to lower your overall payment regardless of the length of the loan," says Pickel. "If you want to be debt-free by a certain year, then you need to find a loan that meets that objective."
Pickel says that sometimes, even with a lower interest rate, you could end up making higher monthly payments because wrapping in the closing costs has increased the size of your mortgage.
Every borrower should look at the cost of refinancing along with the financial benefits before choosing a loan, Busch says. Some borrowers forget that refinancing into another 30-year mortgage can add years of payments, especially if they have been paying on the current loan for a long time.
"A 10/1 ARM (adjustable-rate mortgage) or a 10-year fixed-rate loan can sometimes be a better choice depending on the individual borrower's circumstances," Busch says.
Not shopping around
While many borrowers compare loan offers from more than one lender, they can also shop for title services and save hundreds or sometimes thousands of dollars on their loan.
"Check at least three lenders and at least three title companies before choosing one," Busch says. "There can be an advantage to going to the same servicer that handles your loan now, because they may require less documentation, but I also recommend consulting with at least one other direct lender to compare rates and fees."
Ask the title company for a reissue rate on your owner's title insurance -- Busch says this can save as much as 35 percent on the premiums.
Refinancing when you shouldn't
Charles A. Myers, president and CEO of The Home Lending Group in Jackson, Miss., says refinancing can be a mistake if you don't plan to stay in your home for several years.
"One customer wanted to refinance in order to improve his property and rent it, but he would have ended up with a larger mortgage and then needed a different loan because the property would no longer be his principal residence," says Myers. "The key is to make sure the refinance has a net tangible benefit to the homeowner."
Borrowers need to decide how long they intend to stay in the property and determine the break-even point when the savings outweigh the costs before choosing to refinance, Myers says.
Not keeping up with borrower responsibilities
Homeowners must rely on a lender to refinance, but they have obligations of their own that, if not met, could derail the mortgage refinance. Borrowers must have good credit to refinance, with most lenders requiring a credit score of 640 and above even for a loan insured by the Federal Housing Administration, says Myers.
Lenders can check the borrowers' credit again just before the closing, so you need to maintain good credit and avoid taking on new debt even after the refi has been approved.
"Check the lock-in date for the interest rate on your new loan to make sure you can close before the rate expires," says Busch. "Be sure to turn in all your documentation as soon as it is requested, because a delay could mean that your closing date must be pushed back."
For more information on home loans and refinancing, check out these stories.