Refinancing your mortgage can lower your interest rate and shrink your monthly payments…but it’s not always good for your overall financial health. Those smaller payments can end up costing you thousands of dollars!
So before you decide to take that plunge and refinance, make sure the move fits with your overall financial plans, and won’t end eating into your nest egg instead of adding to it.
7 money traps to avoid when refinancing
Mortgage refinancing can be confusing – there’s a lot to consider, and a lot of numbers get thrown around. What’s more, lenders may try to steer you toward loans that are great for them…but not so good for you.
To protect your finances, take care to avoid these common refinance money traps.
- Lenders have a lot of tricks up their sleeves, and their main ploy is to get you focused on the new lower monthly payment. Make sure you understand everything about the loan, including the new interest rate, lifetime interest paid, loan term, and refinancing fees to get the full picture.
- Adding time – instead of refinancing over just the remaining term of your current mortgage loan – lowers your payments by stretching them out. (For example, you have 22 years left on your mortgage, and refinance with a 30-year loan.) But over time, you’ll end up paying thousands of dollars in extra interest, which will lower your net worth and shrink your nest egg.
- Find out whether your current mortgage has a prepayment penalty. If it does, it can cost a lot of money – up to 4% of your loan balance – to pay off your existing mortgage early.
- Refinancing your mortgage comes with closing costs, just like your original loan did. They usually run to 1% - 3% of the loan balance, so be prepared to take that financial hit.
- There’s no such thing as a “no-cost” refinance. These deceptively named loans do come with costs – you just can’t see them. They get buried inside your loan balance or your new interest rate, and you’ll end up paying interest on both the loan and all of the loan costs.
- Cash-out refinancing lets you walk away with extra money, but that cash will cost you dearly. Not only will you pay interest on every penny you take, your interest rate will be higher than if you’d refinanced without the cash-out.
- Before you apply, check your credit score and verify the amount of equity you have in your home. If your score isn’t excellent and your equity is under 20%, you won’t be eligible for the lowest rates – and that means you’ll pay more money every month and over the life of your loan. In that case, it makes more sense to wait until your score improves and your equity builds so you can get the most favorable terms when you do refinance.
If you decide you do want to refinance your mortgage, be prepared before you start the process. Do some number crunching before you connect with lenders. Look at both the monthly payment savings and lifetime interest savings. If either of those numbers doesn’t work out in your favor, reconsider refinancing. Here’s a reliable mortgage refinance calculator to get you started.