Refinancing means taking out a new home loan with different terms, and using it to pay off your existing mortgage. This means you should already understand the biggest risks associated with taking on mortgage debt, because you’ve already gone through that process at least once. That said, there are some additional risks that you will want to consider before going ahead with your own refinancing.
This isn’t just a risk, but ought to be the foundation for even considering refinancing. Just the same, it is worth emphasizing, because with a traditional mortgage you are simply paying off your home. When you refinance, you are likely trying to save money and pay for your home. Knowing whether you are truly saving money over the long term compared to staying with your current mortgage requires you to calculate your break-even point.
With a little planning and the help of a refinance calculator, this is easy to determine. Once you know your break-even point, then you just have to plan around it: will you still be in your home, or is there a decent chance you will move before then? Can you afford to pay extra each month to shorten the repayment period, or are you refinancing in order to lower your monthly payments? It isn’t enough just to know your break-even point, because you must also use this knowledge to inform your plans, financial and lifestyle.
This is really part of knowing your break-even point, but it bears emphasizing. When you refinance, you go back to zero on your repayment plan. If the savings are great, you may still hit your break-even point soon enough that it is worthwhile, especially if you refinance into a shorter term loan. However, it is easy to overlook the reality of starting over on a 30-year term.
Even if your break-even point is within sight, recognize the risks of changing or losing your job before the mortgage is paid off, and having to leave your home earlier than expected. Similarly, if you are close to retirement, the potential savings may not justify carrying so much debt into retirement. Going onto a fixed income can be a major challenge, and it may be a better option for you to stick to your current schedule and eliminate your mortgage before retiring, rather than risking the long-term debt to enjoy the savings of a refinance.
The next major risk is simply the added costs. One way or another, you are already on the hook for your mortgage. But with a refinance, there are lots of additional fees you will have to pay. Some you may have to pay even if you end up not completing the refinance.
In order to enjoy current rates, you will have to sign a contract with your lender and pay a fee to get that contract locked in at those rates. This doesn’t guarantee you will ultimately qualify for the refinance, nor does it guarantee that you will be able to complete the entire application process before your rate lock expires.
Home values also fluctuate with the market, just like interest rates. It is entirely possible that the market dropped at some point after you purchased, and although interest rates have improved, your home’s value has gone down, sapping your equity. You lender will order an appraisal of the home to determine its current value, and your current level of equity. No matter what report comes back, you have to pay for this service. Simply knowing what you paid for the house, and where you are in repaying your mortgage, is not enough to prepare you for the appraisal, so you’ll want to do your research before you commit money to the process.
Finally, closing costs are pretty much a given. But before you commit to a lender, you would do well to shop around and get some quotes on closing from multiple lenders, just to ensure you don’t overpay. These upfront costs can make a big difference on your break-even point, so you will be glad you spent the time research different lenders before getting locked in with one.
Different mortgages offer different protections to borrowers in the event that you fall behind on payments, or should the bank foreclose on your home. This is especially relevant if you had a government-insured mortgage. Refinancing doesn’t have to mean losing these protections, but you must read the new terms carefully and ask your lender to make certain how your rights will change. Never assume that the only thing that is changing is the rates you are paying--a new mortgage means a whole new contract, and you need to do your due diligence to see what that entails.
Another common feature of mortgages is a prepayment penalty. This just means that, should you decide to pay your mortgage off years early--say, you win the lottery, or receive an inheritance--you will owe fees on top of the remaining mortgage balance. This fee mostly exists so the lender doesn’t lose all the compounding interest that you avoid by paying the mortgage in full. Depending on the language of your loan, prepayment penalties may apply even if you aren’t paying in full. Double check for fees just to make sure that you don’t incur expenses by trying to be fiscally responsible.
Refinancing is ultimately about saving money, and taking control of your mortgage. Doing your research, asking questions, and planning carefully will ensure that you account for the risks, and enjoy the benefits of your new mortgage.