Millions of homeowners today are part of the refinance-worthy club, thanks to a major decline in interest rates. This means they stand to save money on their current mortgage by refinancing into a lower rate. If mortgage rates continue to decline, even more homeowners will have a chance to save.
However, for first-time refinancers, there are usually surprises in store, such as closing costs, credit checks and resetting your payment timeline. Here we help take the mystery out of refinancing and dispel a few abiding myths.
Myth 1: Refinancing is cost-free
Homeowners usually hear a lot about how much they can save by refinancing their mortgage, but they rarely hear about the fees and closing costs associated with doing so. This is an aspect of refinancing that often surprises folks, says Jack McCambridge, general manager at HomeLight Home Loans.
These fees can amount to as much as 2 to 5 percent of the principal of an existing mortgage. For example, if your fees are 3 percent on a $250,000 mortgage, then your upfront payment is $7,500. Many lenders will allow you to roll those costs into your new loan, which will increase the principal you must repay.
“Lenders need to make sure those costs are more than offset by how much homeowners save in monthly interest payment reductions,” McCambridge says. “Many of the same costs come into play when refinancing a home as when receiving an original mortgage, including appraisal, inspection, origination, and title insurance fees. All of these costs are important to take into consideration.”
Myth 2: The interest rate is the most important thing
For many homeowners, the name of the game is to get the lowest interest rate possible to maximize savings. However, the term of the loan is another savings variable borrowers should consider before refinancing.
When you refinance to a loan with the same term, you reset the payment clock, explains Michele Sine, portfolio manager and senior wealth adviser at ImpactAdvisor. For instance, homeowners who have been paying on their 30-year mortgage for 10 years, go back to zero when they refinance to another 30-year loan. This added time (that’s 120 additional monthly payments) costs money as the initial payments are largely interest-only to the service provider.
“It’s an uneven playing field when it comes to payments. In short, the bank always wins, because they get their money first,” Sine says.
Homeowners who are keen on saving money over the life of their loan can either refinance into a lower-rate and shorter-term loan (such as going from a 30-year fixed-rate mortgage to a 15-year fixed-rate mortgage) or make extra monthly payments to repay the loan faster.
Myth 3: A refinance will affect selling the house later
Unlike home equity loans, refinancing your mortgage doesn’t put an additional lien on your home — which means it doesn’t have an impact on when you can sell. Equity-backed loans, such as HELs and HELOCs, use your house as collateral. In those cases, you wouldn’t be able to sell until you paid back those loans, or when you sell you must repay the loan out of any proceeds. But refinancing is strictly based on your ability to pay back the loan as evidenced by your credit and employment history. It just swaps out the primary lien on the home with a new one.
“Refinancing will not affect a homeowner’s ability to sell down the road, since a lender cannot put restrictions on when a homeowner can and can’t sell,” McCambridge says.
Myth 4: You won’t need a credit check
It might come as a surprise that lenders require a credit check for refinancing a home loan. After all, you’ve been repaying the loan on time, so why should lenders want to recheck your credit? But to them it’s a new loan, so they must vet the borrower for the current state of their finances. However, borrowers with an excellent credit profile are rewarded with the lowest interest rates.
“Generally, homeowners with credit scores over 760 will qualify for the best refinancing rates,” says Leslie Tayne, founder and head attorney at Tayne Law Group. “And lenders will likely be looking for your debt-to-income ratio to be less than 36 percent to ensure that you’re not carrying too much debt and can adequately pay back the loan. Some homeowners may be surprised to find out they don’t qualify.”
Before you apply for refinancing, check your credit score and DTI ratio. Since the objective of refinancing is to get the best rate, then you’ll want to make sure your financial picture is good enough to get it, or at least cut your current rate significantly.
Myth 5: You can only refinance your mortgage once
There’s no limit to how many times you can refinance your mortgage. However, the fees are substantial, so it pays to ensure each refinancing makes sense. Use a refinance calculator to see if this is a route you want to take, particularly if you refinanced your home loan in the past few years.
“In reality, you can refinance your mortgage as many times as you want, but many lenders look for a ‘seasoning’ period, or an amount of time in between refinances before they’re comfortable approving another,” Tayne says. “Additionally, the prepayment penalty could come into play here, as well. If you have a prepayment penalty on your loan, you could be charged if you attempt to refinance again.”
Note that few mortgages come with prepayment penalties these days, but it pays to ask about this and other gotchas before you settle on a refinance lender.
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