Mortgage refinancing appears to be an attractive option for homeowners because of its various advantages which are plenty. However, there are several not-so-obvious disadvantages that you may not be aware of.
Thus, there is a need for some kind of refinance rule of thumb to make sure that you really get what you had hoped for.
Rule Number One: Consider Refinancing If Your Credit Score Has Improved and/or Interest Rates Are Lower
One of the benefits is the possibility of getting a lower interest rate compared to what a homeowner is currently paying for his mortgage. This is tricky because even a 0.5 percent reduction in the interest rate would result into substantial savings if you consider the total payments for both principal and interest that you would have made for the duration of the mortgage.
However, this is only possible if your credit rating had increased or the condition of the market is such that the prevailing interest rates are lower compared to that time when you took out your original loan. As for the credit score, if it is presently higher compared to that time when you previously took out the mortgage, a lender would now be willing to offer you a lower interest rate.
Rule Number Two: Compare Total Costs and Not Just Interest Rates
Take note, however, that this is not just a matter of comparing interest rates between the old mortgage and the new one. For you to ensure that you are saving money, always make sure to compare the total payments to be made. This is important because it is also possible to extend or shorten the length of your mortgage.
For example, the remaining number of years to pay your current mortgage is 10 years but you may want to extend it by five years. You might be offered a lower interest rate for the new loan that will now be for a duration of 15 years.
The only way to make sure that you are getting a good deal here is to calculate the total payments that you would be making in the new arrangement. Even with a reduced interest rate, it is still possible for the total amount that you would be paying to be higher compared to what you would be paying with the previous arrangement.
With this rule of thumb, it could be seen that refinancing would not make sense when you are almost through with your original mortgage. With only a few years left, it would be almost impossible to find a refinancing deal that would be able to save you money when comparing the total costs.
Rule Number Three: Think Twice when Considering Cash-Out Refinancing
Sometimes you may be offered a loan amount that is higher than the value of your home so that the net effect is that you get hold of some cash aside from adjusting the term or interest rate of the loan. This is a tempting offer because you might use the extra cash for paying something else such as a vacation, medical bills, debt consolidation, or for home improvement.
However, this has the downside of reducing your equity because in effect you would get a lower amount when you sell your home.
You might want to consider getting some input from your financial advisor before going ahead with this kind of arrangement. Some experts do not favor using this method for paying down short-term loans such as car loans or credit card debt. Sometimes a home equity line of credit or a home equity loan might be a better choice.
Rule Number Four: Always Take the Prepayment Penalty into Consideration
Sometimes your current mortgage might have a condition whereby you are required to pay a certain penalty if you decide to complete the payment of the loan earlier than previously agreed. This usually includes refinancing so make sure to take this into account in your computations when trying to determine whether you would really be able to save some money in the new arrangement.
- Don’t forget to request for a waiver of the penalty in case your current lender will also be providing the refinancing.
Rule Number Five: Always Consider Refinancing Costs
This is important if you expect to transfer to a new home in just a few years and if the current mortgage only needs a few more years to complete. The refinancing costs could exceed any gains that could be made with refinancing.
In summary, use these five rules of thumb as your guidelines when planning to apply for refinancing. Sometimes, the advantages or disadvantages will not be obvious, so be careful before making the leap.