Mortgage Refinancing Do's and Don'ts

Below are helpful refinancing tips and some pitfalls to avoid.

Mortgage Basics

The vast majority of people need a mortgage when buying a home. A mortgage is a type of loan used to purchase real estate. Most mortgage types require the homebuyer to make a down payment to secure the loan. The homeowner makes mortgage payments for the loan term, and the mortgage company holds an interest in the property. Most first-time loans are 30-year mortgages, though you can opt for a 15-year loan. If you fail to make on-time payments or stop paying on your home loan, the mortgage company can foreclose and take the property.

These loans can be fixed-rate or adjustable-interest-rate mortgage loans. With a fixed-rate mortgage, your payments and interest rate remain stable. Your monthly mortgage payment amount can change with an adjustable-rate mortgage.

In addition to conventional loans, the most common types of mortgages include government-backed programs like the Federal Housing Administration (FHA) loans and Veterans Affairs (VA) loans.

The mortgage lender you closed with may not be the one to whom you make payments. After closing, Fannie Mae, Freddie Mac, or another investor generally buys your original mortgage loan.

Why Refinance Your Existing Mortgage?

Refinancing is not a second mortgage. It is a new loan that pays off your current mortgage and sets up a new mortgage with more favorable terms.

Homeowners consider refinancing for many reasons, and are many different types of refinances available. Depending on your financial situation, you may want a cash-out refinance to access your home equity rather than apply for a home equity loan. Some refinance to remove the need for private mortgage insurance on their new mortgage. 

You could want to switch to a fixed-rate loan rather than an adjustable-rate mortgage for added stability. Perhaps the market has swung and you want to take advantage of lower rates on mortgage interest. Your finances might have improved since taking out your original mortgage, and you might want to switch to a 15-year loan instead of your 30-year mortgage to reduce the amount of interest you’ll pay.

The Do’s of Home Refinance

Do research on the refinancing process. Refinancing your current loan is similar to taking out your original mortgage. You may need a home appraisal, and you will pay closing costs.

Do calculate your “break-even point”. There are many costs involved in refinancing. Your break-even point is where your monthly savings, or savings over the life of the loan, are equal to your costs. Any additional savings are your benefit.

Do look at the different types of refinancing available. The VA, USDA, and FHA offer a streamlined refinance option, as do some lenders. This is a more straightforward process and will save you an appraisal fee on your home. A cash-out refinance will allow you to tap into your home equity.

Do look at how a lower interest rate may impact your tax returns. Paying less mortgage interest will give you less to deduct at the end of the year.

Do compare the cost of refinancing with the cost of your existing mortgage. Federal”Truth in Lending”laws require that lenders give you certain uniform disclosures containing the annual interest rate charged, total finance charge, loan amount, and other costs. When choosing a lender, you must consider all refinancing costs to compare your options.

Do refinance your higher-interest-rate loans with lower-interest-rate loans if the terms of the loans are comparable. As borrowers, you need to be certain that the new rate you will be paying is not a”teaser”rate that will go up after an introductory period, hitting you with larger payments.

Do refinance your secured debts if the new loan is for the same length or less than you have left on your old loan. The interest rate on the new loan should be lower than the interest rate on your existing loan. The rate on the new loan usually must be substantially lower than the interest rate on the old loan to make up for costs and fees associated with the new loan.

Do consider refinancing your home to pay off debt for tax purposes, but only if you are not in financial difficulty and not at risk of losing your home. Only refinance if it is beneficial from a tax standpoint or if the lack of benefit to your taxes is outweighed by other benefits of refinancing..

Do watch out for refinancing scams. If you get unsolicited offers to consolidate all your loans into one mortgage, to sell your home with an option to repurchase it, or to save your home from foreclosure, beware! If an offer sounds too good to be true, it likely is.

The Don’ts

Don’t refinance your bank loan with a finance company to get a lower monthly payment. The interest rate with the finance company will likely be higher than the bank loan and usually contains fees, insurance, and other costs.

Don’t refinance to lock in a lower interest rate without looking into the fees and costs of the new loan. You may end up paying more for the new mortgage than the lower interest rate and lower tax deduction are worth.

Don’t refinance your home for more than its market value. Lenders that offer loans exceeding your home’s value can charge much higher interest rates than standard mortgage lenders. You may be unable to deduct some of the interest you are paying on the new loan. Worse, you risk losing your home through foreclosure if you can’t make the payments.

Don’t refinance your home to pay off unsecured debts like credit cards. Unsecured creditors have little recourse to collect the debt. You can often negotiate a settlement or new payment terms with credit card companies. If you refinance your home and fall behind on the mortgage, the lender can foreclose and you could lose your home.

Don’t refinance an unsecured loan as a secured loan. If you do, you risk losing the property you pledged as collateral.

Don’t refinance because of pressure from a debt collector. Debt collectors try to intimidate you into refinancing or tapping into your home equity so that they will get paid because, well, they legally can’t do much else.

Does Refinancing a Mortgage Hurt Your Credit Score?

Refinancing your mortgage can affect your credit score in several ways. These include:

• Multiple credit checks may lower your credit score. Before approving your loan and giving you new credit, banks and other financial institutions will pull your credit report to get your credit history. This may temporarily lower your credit score.
• When you refinance a loan, you will close your old loan. That may lower your credit because you closed a long-standing credit account.

Even though your credit score may take a hit when you refinance, it should improve with time because of your strong payment history. Make sure to make repayments on time.

Is It Better to Refinance With Your Current Lender?

No law says you have to refinance with your current lender. Sometimes, it may be beneficial to do so. Other times, it is better to go with a different one. When choosing a lender, take into account the following:

• The time it takes to get a new loan
• The interest rate on the loan
• How much the upfront and ongoing fees are

Every situation is different. Take the time to compare different rates and offers.

Can You Negotiate Refinance Rates?

Yes, you can negotiate your refinance rates. Lenders will give you an offer, but most offers are negotiable. Some fees may be non-negotiable, but others are also open to negotiation.

How Long After Bankruptcy Can I Refinance My Mortgage?

The answer depends on the type of bankruptcy you filed and what type of mortgage you have. Bankruptcy remains on your credit for seven to 10 years, which makes obtaining a refinance loan difficult.

Chapter 7 and Chapter 13 bankruptcy are the most common bankruptcies available for individuals. Chapter 7 bankruptcy liquidates or sells your eligible assets to pay your creditors.

If you underwent Chapter 7 bankruptcy, there is a waiting period from the date of your bankruptcy discharge or dismissal before you may apply for a mortgage refinance loan. This waiting period is as follows:

• Conventional loans: Four years
• FHA loan: Two years
• VA Loan: Two years
• USDA Loans: Three years
• Jumbo loan: Seven years

Chapter 13 bankruptcy creates a repayment plan for your eligible debts. You pay over three to five years to settle your debts. Once you complete the repayment plan, the court discharges your remaining debts. You must wait four years for a conventional loan if the court dismissed your bankruptcy, or two years after discharge to refinance. For FHA, USDA, and VA loans, you must provide proof of on-time payments for one year. You are required to wait seven years before applying for a refinance if you have a jumbo mortgage loan.

If you have additional questions about how your bankruptcy affects your mortgage and refinance options, speak to a bankruptcy attorney.

Considering Refinancing? Speak to an Attorney

It’s complicated, confusing, and time-consuming to refinance your mortgage. Although you can get the mortgage lender to assist you, they often don’t represent your best interests. Talk with a real estate attorney if you are considering refinancing or have questions about the process. An attorney can protect your rights and help you find a loan that works best for you.