Top Five Things to Consider When Refinancing Your Home

The greatest mistake homeowners make in negotiating a refinance is failing to take into account the total cost of the loan and how the required monthly payments will affect their budget. Before moving forward, there are five crucial points to consider or steps to take to save yourself from getting in over your head.

1. Know when and how much.

Unless you are offered an interest rate that is 1% to 1.5% less than that you are currently paying, a refinance is most likely not worth the associated costs. Opt for a “cash out” refinance, one in which you borrow more than the amount of the mortgage (tapping the equity you have in the home) only in extreme situations. (For instance when you need to resolve debt or plan to make a home improvement that will significantly increase the value of the property.) Beware of getting “underwater,” borrowing more than the home is worth, which is of special concern in the current depressed market.

2. Understand the total cost of the loan.

Don’t pick a lender based on the lowest rates. You’ll also be paying closing fees for things like processing the application, checking your credit rating, and legal fees if lawyers have to get involved. Conservatively, expect those fees to run about $3,000. If you’re not going to make back the closing fees in two or three years or if you plan to move in a year, don’t refinance.

3. Get a good faith estimate of the closing fees.

You are legally entitled to a good faith estimate of the associated fees within three days of the time the lender gets your application. If you move forward, take the estimate to the signing. You should not pay fees that are markedly different from those put forward in the estimate.

3. Look at potential penalties.

In addition to closing costs, you may be facing pre-payment penalties from your existing mortgage. If so, figure that amount into the total cost of the loan before making a decision. (Pre-payment penalties are more common if you’re going with another lending institution.)

4. Get a written rate lock.

Get the interest rate you are being offered by the mortgage company in writing, including the length of time the rate will stay at that level and any other pertinent details of the loan pertaining to the rate. Don’t move forward until the rate lock has been signed.

5. Understand the private mortgage insurance factor.

If your new loan is for more than 80% of the value of the home, you may be required to also pay for private mortgage insurance, an ongoing expense in addition to the mortgage payment. On the flip side, however, if you were required to take out such a policy as a condition of your previous loan and if you’ve paid enough off, a refinance may allow you to discontinue the coverage.

Don’t be fooled by an attractive interest rate and ignore all the hidden costs or fine points of a loan’s terms. Unless you are gaining at least a percentage point advantage and can recoup the closing costs over a two to three year period, a refinance won’t be to your advantage. The key to successfully negotiating the process lies in putting pencil to paper and knowing to the penny the total cost of the loan and then comparing that figure against your monthly budget. Homeowners who don’t take these necessary precautions can quickly find themselves deep in a mortgage hole.