Refinancing your mortgage can save you a lot of money, especially with interest rates as low as they are right now. However, there are also some things to look out for before you rush in.
The following are three common, but often overlooked, mistakes that people make when refinancing that can cost them money:
Refinancing too often
With interest rates once again falling to record lows, many people who've already refinanced their mortgage at least once before are rushing to do so again, to lock in the lowest rate possible. While that's an attractive proposition, it's one that can lead you into trouble if you're not careful.
The problem is that refinancing costs money. To refinance a mortgage, you'll typically pay about 3-6 percent of the loan balance in closing costs, perhaps less on high-balance loans. So for refinancing to make sense, you need to save enough in interest to eventually cover the closing costs.
Some homeowners, in chasing ever-lower rates, make the mistake of refinancing too often. They pile up closing costs over time, so their loan balance keeps increasing - negating the benefits of refinancing in the first place. There's no hard-and-fast rule on how to avoid this, but generally speaking, if you haven't yet recouped your closing costs from your previous refinance(s), you want to proceed with caution before refinancing again.
Using taxable value as an appraisal
Before you go to the trouble and expense of refinancing, you're going to want to know if you can qualify for a new mortgage in the first place. With many homeowners in low- or negative equity situations due to falling home values, it's important to know what your home is worth before refinancing.
The way this can cost you money is when you pay for an appraisal and possibly an application fee as part of the refinancing process and it comes back that you're underwater on your current mortgage - owing more than the property is worth - so you can't qualify for a refinance. Obviously, it's better to know what your home is worth before you start paying money for a refinance.
Some people make the mistake of using their property tax statement as a guide to what their home's appraised value will be. Unfortunately, assessments for tax purposes tend to be higher than those done for purposes of obtaining a loan - often, quite a bit higher. You can't simply look at your property tax assessment and deduct a certain percentage and assume you're ok.
The best way, short of paying for an appraisal, is to find a few homes in your community that 1) have sold recently, 2) are similar to yours, 3) are in your neighborhood or others with similar home values, and 4) were previously sold about the same time you bought yours. Using 3-5, you can get a pretty good idea of how home values in your area have changed since you bought your home.
Resetting to a longer loan term
When people refinance a mortgage, they typically choose a new fixed-rate loan over a certain term - often 30 years. The problem is, if you've already been paying on a 30-year mortgage for a number of years and refinance into a new 30-year loan, you're postponing the date you'll finally pay it off.
While that can lower your monthly mortgage payment by spreading the remaining principle out over a longer period, it also means you'll be paying interest longer as well. Over the long term, that reduces or may even eliminate the interest savings you're trying to realize from refinancing in the first place.
A better option is often to refinance into a mortgage with a term about as long as what's remaining on your present mortgage or perhaps even a bit shorter. For example, say you've been paying on a 30-year mortgage for seven years and have 23 years left. Refinancing into a 20-year loan will actually allow you to pay off your loan a bit sooner and may still allow you to reduce your monthly interest payments - particularly since shorter term rates such as 15- and 20-year mortgages are currently a good bit lower than 30-year rates.