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Refinancing Home Loans: Three Mistakes to Avoid

Posted by  on Aug 10, 2010
 

Refinancing your mortgage can get you lower payments, accelerate your home loan payoff, help you nail down a lower interest rate, or let you cash out home equity. But refinancing home loans also gives you the chance to make ugly and expensive mistakes. Learn what the top three refinancing mistakes are, and how to avoid making them.

Mistake #1: Ignoring Government Programs

Refinancing homeowners may think government mortgage programs are only for first-time buyers or those with modest incomes. In fact, there are no income limitations for most programs, and they may be the best option for those with less equity or mediocre credit scores. And you may need very little equity to get a loan--as low as 3.5%.

Underwater on your mortgage? The HARP refinance program is a government program that may allow you to refinance a Fannie Mae or Freddie Mac loan for up to 125% of your home's value. Underwriting guidelines for the program are less stringent than Fannie or Freddie requirements, and the fees are capped at 2%.

Mistake #2: Overlooking the Future

Refinancing correctly means considering how your time-frame and circumstances affect your choice of refinance mortgage. Your time-frame determines your best mortgage program and what you should spend to get it.

  • Starter home? Younger homeowners should plan for big changes in their futures--which can involve a change of address. Unless you're now rooted in your home forever, a 3/1 or 5/1 hybrid ARM could be your best mortgage--interest rates on these products are 1% to 1.5% lower than rates on 30-year fixed rate mortgages.
  • Moving soon? In addition, changes in time-frame equal changes in APR (annual percentage rate). Not understanding that can result in a very expensive mistake. Many articles recommend choosing the lowest APR when selecting a mortgage, but that may be very wrong. The length of time you keep your home loan can alter the APR extremely.
    • For example, consider a no-cost 30-year mortgage with a stated interest rate and an APR of 5.25%. The APR will always be 5.25%, because there were no upfront fees. Then consider another loan with an interest rate of 4.75%, which costs $2,000 plus 3 points, yielding an APR of 5.06%. The 5.06% APR appears to be the better deal--but is it? APRs are calculated with the assumption that you keep your mortgage for thirty years. If you keep it only five years, the APR on the second loan shoots up to 6.382%! When your time-frame is short or unknown, work to minimize or even avoid any upfront fees.
  • Hard times? Finally, consider that in the future you may not be able to refinance. Retirees whose income drop, or who switch to part-time or self-employment may find themselves under-qualified to refinance. And younger families who lose income if a parent leaves the workforce, or mid-lifers who to start new careers may find themselves in the same boat. Best to refinance before life-changers if you can.

Mistake #3: Not Shopping for Best Mortgage Rates

Obtaining several mortgage quotes is the only way to know that you're making your best deal. Mortgage lenders are not all the same, and interest rates can vary for many reasons. Some lenders are more efficient than others and operate on lower profit margins. In addition, lenders adjust their portfolios to balance their risk; that can mean better deals for those who meet certain geographical criteria or have the desired credit profile. In a nutshell, mortgage lenders' rates and terms vary, and by getting several refinance quotes, you can take advantage of rate differences and find the best mortgage rates.

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