When mortgage rates drop in America, many people seek to refinance their mortgages at the same time. It may even take on aspects of a fad, because “everyone” you talk to is doing it. This happens when rates drop relatively quickly to a new lower level than they’ve been for the last decade or so. Everyone with a mortgage can save enough money to justify the pain of a refinance.
Here are some things you should know and watch for before your refinance:
Costs: Refinancing your mortgage will cost about 2 percent of the mortgage balance. Although this cost can typically be borrowed with the payoff, the cost is real. Your new mortgage will be bigger than the old one, meaning that you will give up years of principal payments to refinance.
Goals: People often focus on the difference in the monthly payments of the old and new mortgage to determine whether or not to proceed with a refinance. If the mortgage was 10 years old, much of the reduction in payment will simply be due to stretching the mortgage over a fresh 30 years. Focus instead on the interest savings. If you have a $200,000 mortgage at 6 percent and you can get a new mortgage at 4 percent, you can save 2 percent or about $4,000 per year.
Shorter: Generally speaking, mortgages with shorter maturities have lower interest rates. Many people can afford refinancing their 5 or 10 year-old mortgage with a new 15 year mortgage because the interest rate is so much lower. By doing this, they put themselves on track to pay off the mortgage entirely before the original schedule rather than later. Smart move!
Interest rates: The market for mortgages is so efficient and the underwriting standards are so universal that lenders all offer the same interest rates to borrowers with good credit. Mortgage brokers, however, charge different and varying fees. Some are unethical and charge unsuspecting customers two or three times the market rate. Be sure to work with a reputable mortgage broker. Big banks, sadly, vary in their treatment of customers as much as the independent mortgage brokers. Proceed with caution, wherever you go.
Value: The value of your home must significantly exceed the balance of the mortgage in order for you to refinance. For many homeowners in 2010 and 2011, this prevented refinancing. As real estate values have begun to recover in 2012, it is likely that many more people will be able to refinance in 2013 if interest rates remain low.
No prepayment penalty: For the last generation, the U.S. Federal Government has effectively prohibited prepayment penalties on most mortgage products. In effect, that allows borrowers to refinance and get a lower rate every time the rates fall significantly. Some borrowers have refinanced repeatedly. Since 1980, mortgage rates have been in a steady decline from 13 percent down to about 3 percent at the end of 2012. It is unlikely that mortgage rates will go much lower, potentially putting an end to this generational cycle.
Refinancing a home is a big hassle with a potentially large reward. Proceed with caution, but remember that refinancing can save you big bucks over the life of your mortgage.
This article was originally published on FamilyShare.com. Check out these other related articles: Take the mystery out of refinancing your mortgage, 6 insider tips for refinancing your mortgage and 10 Things to know about a reverse mortgage.