5 pitfalls of refinancing (© Jeffrey Coolidge/Getty Images)

© Jeffrey Coolidge/Getty Images

With mortgage rates hovering near record lows, a growing number of homeowners are racing to refinance — only to find the process riddled with obstacles.

For one, homeowners often have to wait months before they can secure a new loan at a lower rate, The Wall Street Journal reported in May. But on top of that, credit requirements remain tight, so borrowers approved for mortgages before the downturn might not pass muster now. And even those who do get approved often find their homes do not appraise above the minimum threshold. "You have these big wild cards out there right now; you can't simply look at the lower rate," says Robert Lattas, a real-estate attorney in Chicago. (Bing: Where are interest rates right now?)

Of course, refinancing may be worth all the hassle, advisers say. The new loans mean smaller monthly payments — a godsend for homeowners struggling to make their current payments. And the latest version of the government's refinancing program, dubbed HARP 2.0, aims to help homeowners who owe more on their home than it's worth.

Despite those benefits, experts say homeowners should first consider the drawbacks. Refinancing tends to extend the mortgage payment period, so a borrower who stays put in the home for the long run could be stuck with the mortgage well into retirement, says Doug Miller, executive director of Consumer Advocates in American Real Estate. Separately, homeowners who plan to sell their home a few years after refinancing might find the costs of getting the new loan outweigh the savings.

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That said, for those determined to refinance, here are the five things financial advisers say to weigh first.

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1. Refinancing means starting from scratch. When homeowners sign up for a 30-year mortgage, the monthly payments made during the first seven years will pay down about 5% of their principal, with the rest going toward interest, Lattas says. Instead of making a dent in their principal, homeowners who refinance after the seven-year mark effectively start the payment process all over again.

Refinancing could also set them back over the longer term, says Stuart Feldstein, president at SMR Research, which tracks mortgages. Here's an example: A homeowner five years into a $200,000 mortgage at a 5.5% interest rate might decide to refinance to a 4% rate. Fifteen years after refinancing, the homeowner will owe around $145,000, meaning equity of roughly $55,000 in the home. If the owner had kept the original mortgage, the amount owed would be $139,000 and the equity would be $61,000. In other words, unless a borrower needs to lower the monthly payment in order to hold onto the home, it might be good to reconsider refinancing, Feldstein says.

2. Closing costs could outweigh the savings. Homeowners who refinance have to pay closing costs, and those expenses can be larger than the savings, depending on how long the borrower plans to keep the home. Closing costs typically run around 1.5% of the loan amount, says Greg McBride, senior financial analyst for Bankrate.com. Borrowers should compare those expenses to the amount they'll save each month with a lower interest rate and find the break-even point: how long they'll need to be in that home before they recoup the expenses.

A borrower who refinances a $300,000 mortgage will pay about $4,500 in closing costs. Assuming the rate on the new mortgage is a full percentage point lower than the original mortgage, he'll save $178 a month, which means he'll need to stay in the home 25 months to recoup the amount he spent on closing costs before he can start pocketing savings.

Borrowers who refinance into a 30-year fixed-rate mortgage and move before they reach the break-even point will lose money. Instead, homeowners who are certain they'll be in the home for just a few years and want to lower their monthly payments during that period can consider refinancing into an adjustable-rate mortgage. The average rate on a 5/1 ARM, where the interest rate is fixed for the first five years before becoming variable, is 3% — that's more than a full percentage point lower than the average rate on a 30-year fixed-rate mortgage, according to Bankrate.com. In this case, though, if the borrower doesn't sell his home by the fifth year, the rate on the mortgage will adjust and could rise significantly.

3. Terms can be confusing. With refinances taking longer to process, experts say there's more confusion about when borrowers should stop paying their original mortgage. Since the new monthly payment on a refinance will be lower, borrowers typically don't pay the original mortgage the month their new mortgage is expected to come through. But that strategy works only if the refinance is processed on schedule. If there's a delay and borrowers don't make a payment on their original mortgage, they'll fall behind on their mortgage payments. That could derail the entire process.

In general, lenders offer a two-week grace period after the mortgage payment is due. Borrowers who miss that will incur a 5% charge on their monthly payment. If they're 30 days past due, they could see their credit score drop by around 100, Lattas says. A lower credit score will in turn increase the interest rate that borrowers get on their refinance, he says, which can make refinancing less of a deal. In the worst-case scenario, the lender might refuse to go through with the refinance.

Borrowers who have an auto-pay set up to make their monthly mortgage payments should consider keeping it until their new mortgage is ready, Lattas says. And they should check in regularly with the lender to get status updates on the refinance and find out whether any new delays are expected.