Thinking of Refinancing?

6 signs you may not be ready

Are you thinking of refinancing? It can help you lower your interest rate, take cash out, and improve your financial prospects. But, if you don’t know what to look for or what mortgage pitfalls to avoid, you could end up missing the point.

If any of the following is true for you, you should change your thinking before you change your mortgage.

1. YOU'RE TOO FIXATED ON INTEREST RATES

First off, when considering a loan, it’s important to look at not only interest rate, but also APR (Annual Percentage Rate). APR  factors in not only interest, but also discount points, insurance and other expenses. Therefore, it’s a more accurate representation of what you’ll actually be paying.

Secondly, a low rate does not equal a good mortgage. Many lenders will lure you with a low interest rate, but charge you thousands in fees and discount points to secure it. Moreover, if these fees bring your loan-to-value ratio above 80%, you may also be charged mortgage insurance.

Thirdly, beware of the fine print. Alongside a low rate may be all kinds of unfavorable terms that can cost you in the long run. One example is a prepayment penalty, which penalizes you for paying off your mortgage sooner (even if you’re selling the property).

In the end, fixating on interest rates can result in loss of equity, higher closing costs, unfavorable terms, and a higher APR.

Scenario

You obsessively track rates for even the smallest dip in basis points. You’re even entertaining the idea of buying down your rate, so that you could get the best mortgage on the block. Unfortunately, this means you’re more likely to fall prey to hidden costs and unfavorable terms.

2. YOU'RE NOT CONSIDERING YOUR OPPORTUNITY COST

When you just focus on paying off your mortgage faster, you may be incurring opportunity costs. Opportunity cost is money that you miss out on because you chose a different course of action. Unless you have no student loans or credit card debt, a healthy investment account, and an emergency fund, chances are your dollars could be put to better use than solely paying down your mortgage.

HOW THE MATH WORKS

Most homeowners pay less than 5% for their mortgage. Considering that your mortgage interest is tax-deductible, that low rate becomes even lower. So the question is: why prioritize paying off this low-interest debt when it would better serve you to put your dollars elsewhere? Like, for instance, in stocks and bonds. The average return on U.S. stocks has been around 10% annually when invested over time. Tax-advantaged accounts like your traditional IRA or 401(k) show even greater returns given that you can deduct your contributions from your taxable income.

Overall, refinancing to pay off your mortgage may still be the right financial decision for you. Just beware of tunnel vision or you could miss out on more lucrative opportunities.

Scenario

You’re too focused on paying off your mortgage to see the bigger picture. The result is that your math doesn’t add up and you miss out on bigger opportunities.

3. YOU DON'T KNOW YOUR BREAK-EVEN POINT

When thinking of refinancing, what you want to find out is your break even point. That’s the time it will take for the amount you saved to exceed the cost of refinancing. It’s simple to calculate. Just take the total cost and divide it by the amount you will save each month on your payments.

So, if refinancing costs you $5,000 and it saves you $200 each month, it will take 25 months to start seeing returns. If you plan to sell the property before that time, even if it significantly improves your rate and terms, refinancing will actually cost you more than save you.

How to Calculate Your Break-Even Point

Scenario

You’re too focused on paying off your mortgage to see the bigger picture. The result is that your math doesn’t add up and you miss out on bigger opportunities.

4. YOUR CREDIT SCORE COULD USE SOME WORK

When it comes to credit, your individual score doesn’t matter as much as the tier it lands on. In other words, there’s a dramatic difference between a 719 (a Good score) and a 720 (a Great score). For a 30-year fixed rate loan of $500,000, that could mean a difference of $22,201 over the life of the loan according to MyFico.com.

What’s more, improving your score could be as simple as checking your credit report and disputing any mistakes. 20% of credit reports have errors on them, which means that you could be getting higher quotes than you deserve.

Don’t just aim to meet the basic credit requirements for refinancing. Check your credit score to make sure you don’t need to dispute mistakes or move up a tier.

Standard Credit Rating Scale

Scenario

Your credit score meets the basic requirements for refinancing, so you move on to the next hurdle. However, you fail to consider the effect that your credit score actually has on your mortgage. By not making sure your credit is mortgage-ready, you could end up paying a lot more than you need to.

5. YOU DON'T KNOW THE FINANCIAL TOOLS AT YOUR DISPOSAL

While refinancing can help you achieve a net positive outcome, there may be other options better suited for your goals. Here are three quick examples:

  • Mortgage Recasting:
    Paying a large sum off your principal so your mortgage can be reamortized into lower monthly payments. If your goal is to lower your payments and you happen to be sitting on a large sum of money, recasting will allow you to lower your payment without paying the closing costs of refinancing (typically ~2%–3% of your loan amount).
  • Accelerated Payments:
    Making payments on top of your monthly bill as a way of directly reducing your principal balance. If you’d like to repay your mortgage faster and there’s no prepayment penalty, this is a great tool to consider (provided you’re not paying more in opportunity costs — see point 2).
  • HELOC or Home Equity Loan:
    Also known as a second mortgage, these loans help you take cash out of your home without incurring all the costs of refinancing. HELOCs typically have slightly higher rates, but they only apply to the amount you take out, not your whole mortgage. If you need a short-term loan, like if you want to renovate before selling, a HELOC loan may be cheaper thank refinancing.

THE BOTTOM LINE

Refinancing may be one way to improve your situation, but it may not be the best way. Make a calculated decision by exploring different financial tools.

Scenario

You think refinancing is the only tool in your homeowner’s belt. But if that’s your hammer, then everything will look like a nail no matter your circumstance.

6. YOU DON'T HAVE YOUR SH*T TOGETHER

Getting a mortgage takes time and preparation. You’ll probably need a house appraisal, verification of income and employment, and more. If you’re self-employed, the amount of required documents is even greater. If you’re thinking about refinancing, get your ducks in a row early so that you don’t miss your chance to act if a great opportunity comes up.

TO LOCK OR FLOAT? HOW TO DECIDE 

Talk to a mortgage consultant. They’ll advise you on how to proceed and whether it’s a good time to lock in that rate, float, or even accept a rate lock float down (which is when you pay a little bit of money in exchange for the option of floating down if rates drop).

Scenario

Rates plummet so you decide to refinance. You call “your guy” to try to lock in that rate, but underestimate what goes into getting verified. So, by the time your application is ready, rates have spiked and you’re stuck with an uncomfortable decision: to settle for what’s available now or risk your position further by waiting. . .

BONUS TIP: SHOP AROUND FOR A BETTER MORTGAGE

In 2018, U.S. home buyers left between $6 and $11.3 billion on the table by not shopping around for a mortgage. And that’s just in interest alone. This statistic doesn’t account for discrepancies in fees, points, buy-downs, etc. Despite countless studies showing that you can save thousands just by getting a second quote, most people simply don’t take the time. Explore your mortgage options and don’t leave your money on their table.

Scenario

Rates plummet so you decide to refinance. You call “your guy” to try to lock in that rate, but underestimate what goes into getting verified. So, by the time your application is ready, rates have spiked and you’re stuck with an uncomfortable decision: to settle for what’s available now or risk your position further by waiting. . .

If you’re thinking of refinancing, make sure to avoid these common mortgage pitfalls. Before you commit to paying fees and gathering paperwork, make a commitment to yourself and your future: explore your options.

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