A steep drop in mortgage rates over the past 15 years has made refinancing a common exercise—so common you would think that people would know more about it. And yet, misconceptions about refinancing persist.
1. It makes sense to refinance whenever mortgage rates drop.
Rates go up and down all the time, and not every drop in rates creates a good refinance opportunity. Keep in mind that there are closing costs to overcome, and there may also be an early repayment penalty on your existing mortgage. So, look for a more substantial drop—say at least 1 percent—before you let falling mortgage rates trigger an attempt to refinance, and be sure to factor in all the relevant costs.
2. Lowering the mortgage rate is the only way to reduce my monthly payments.
If you are having trouble keeping up with your mortgage payments, you may be crossing your fingers and hoping for lower interest rates to bail you out. Be advised, though, that there are other ways of lowering your mortgage payments, and that is fortunate because rates are not likely to drop substantially from today’s levels. Lengthening out the remaining term of your mortgage—for example, if you are 5 years into a 30-year mortgage, you could refinance to a fresh 30-year mortgage—is often an effective way to lower mortgage payments because it stretches the balance over a longer period of time. Be advised, though, that this is likely to result in a higher total interest cost over the life of your mortgage.
3. Reducing monthly payments always makes sense.
Lowering monthly payments is tempting, but as noted above, it can result in higher long-term interest costs. In addition, you have to overcome upfront closing costs when you refinance. You’ll also build equity more slowly by stretching out the loan to lower your monthly payments.
4. Lower payments are the only reason to refinance.
A lower monthly payment might have the most immediate impact on your mortgage, but there are other good reasons to refinance, even if they result in higher payments in the near term. For example, switching from an adjustable-rate to a fixed-rate loan will stabilize your monthly payments, and might make sense especially when mortgage rates are near historical lows. Also, switching from a longer to a shorter mortgage is likely to raise your monthly payments, but it could result in lower total interest payments over the life of the loan. This is because you will be paying interest for fewer years, and you also may benefit from the lower rates typically offered on shorter loans.
5. It doesn’t matter how long I plan to stay in the house, if I can lower my mortgage rate it makes sense to refinance.
Two people might have what looks like the same refinance opportunity—same current terms and being offered the same refinance terms—and yet, it might make sense for one person to refinance but not the other. The difference? How long they plan to stay in the house. The hurdle of closing costs means there is a breakeven point at which monthly payment savings overcome the upfront costs. If you won’t be in the house long enough to reach the breakeven point, then refinancing probably won’t benefit you.
6. I shouldn’t worry too much about future changes in my mortgage payments because I can always refinance if they get too onerous.
Don’t make mortgage decisions based on the assumption that you will always be able to refinance. This is especially true with regard to things like balloon payments or adjustable rates that might make your mortgage unaffordable in the future. As many people found out during the housing crisis, when the time comes to refinance you might find that you lack the credit standing or the equity to do so.
7. My current lender will give me the best shot at refinancing.
Having a relationship with a lender can be helpful, but any time you refinance a mortgage you should look at it as a fresh opportunity to shop for rates. Give your current lender a shot, but make sure they can hold their own against what the market has to offer.
8. I don’t have enough equity to refinance.
Having equity in your home can be an important, but it is not always necessary in order to refinance. If you have a loan owned by Fannie Mae or Freddie Mac, you might qualify for the federal government’s Home Affordable Refinance Program, which allows you to refinance an underwater mortgage if you have kept up with the payments. If you have a VA loan, the Veteran’s Administration’sInterest Rate Reduction Refinance Loan might allow you to refinance without a new appraisal. Finally, it may be worth talking to your current lender. Since they are already at risk for the amount you owe, they might be open to discussing refinance terms even if your home has declined in value.
9. I should go with the lender with the lowest advertised rate.
Lenders advertise their lowest rates, which apply to home owners with excellent credit and a significant amount of home equity. If you lack either of those qualifiers, it is especially important to compare rate quotes specific to your situation.
10. Rate quotes are all that matters when comparing lenders
Rate quotes may be the focal point of lender comparisons, but don’t overlook the fact that different lenders will charge different fees and closing costs. Be sure to factor these in alongside your rate comparisons.
Mortgage refinancing is as much about your goals and situation as it is about interest rate conditions. So, rather than make sweeping assumptions about whether it makes sense to refinance, it is always better to look closely at the specifics of your situation before you decide.
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