5 pitfalls of refinancing
Know what you are getting into before you decide whether refinancing is worth the hassle.
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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.
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.
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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.
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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.
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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.
Another option the home owner has is to hire an appraisal themselves from a certified real estate appraiser to get a real number for the value of their home. Though a realtor may be familiar with the market, they often use the term "dollars per square foot" which really doesn't take into consideration improvements to the home, the site value or a built-in pool. For example, my house was built in 1946 is 1650 square feet and located in a very desireable area and school district. My home is valued at $260,000. Does my house cost $158 per square foot? NO. Because the site (lot) is worth $120,000. Home value less site is $140,000 which equals 84.80+/- dollars per square foot. Dollars per square foot is really meant to be used if you are building a home on land you own so you know the cost to build or if you are renting commercial space so you know how much a building costs to rent. If I had a pool which cost $50,000 to install doesn't increase value of home by $50,000. Typically, a pool is valued between $10,000 to $20,000. Like a new car a pool depreciates starting the day it's installed.
A realtor factors in items that can't be easily proven like a greenbelt lot which most of the time just means no house built behind your house. They are salesmen. They paint the picture and sell the sizzle. Take it from an appraiser with almost 20 years experience ------ if you want the real number for the value of your home spend the money and hire your own appraiser. The appraiser is an unbiased third party not blowing pipe dreams on what they think they could sell your house for. Often I will go to appraise a house and the home owner had a realtor friend do an AVM or pull some comparables for them. A realtor cannot pull comparables. The realtor can pull sales in the area but ONLY an appraiser can determine which sales are compareables. That's why they are realtors who sell and I am an appraiser. The appraiser is the one who's name is signed at the bottom of the appraisal not the realtor. Many time I call a realtor to ask where they got the listing price and mostly they say that house sold for xx per square foot so this one is nicer and should sell for this much per square foot. Or they send me sales that are 800 to 1,200 sqft larger with a pool as sales to consider or sales that are between 6 months to a year old. Lenders want recent sales within 90 days. If the house has been on the market over 180 days chances are it's priced too high and any sales to support that price are 9 months old or older. Appraisers aren't miracle workers what it is is what it is. We have to be able to prove the opinion of value.
My god you people at MSN are Idiots....you must think we are all as Dumb as you....
What a homeowner should do esp. if the loan is paid down a few years (say from a 30 yr that's 5 years already paid) to refi on a lower term 20 years for e.g. . I had done this 2x for the property I currently "own" after 4 years refi'd from a 30 to a 20 yrs. then refi'd again at 3 years later to a 15 yr all the while the payments were less than the former. So basically I've been on a 15 yr for 3 yrs so far, if one adds to the principal (which one should do when it becomes feasible) for e.g. paying 4 weeks for your monthly (adds 1 month extra payment), will lessen the loan to a 12 yrs or so, I should be paying off the mortgage in about 9 years, so I started with a 30yr, paid off in about 19 years. One can do it quicker with more payments for e.g. to the principal which most loans will allow. I would never refi to the same term, unless one definitely knows that they will move in the next 3-5 years, and can 'prudently' save the cash savings each month. But buyer should beware of some instituions that might want ot nail you with extra charges or points. You can aggressively questions this and usually they will drop extra charges w/discounts (last loan I did) Shop around!