Your home is likely your largest single investment. When refinancing your mortgage, treat it like you would any investment by analyzing how the financial costs and returns meet your goals. This requires a clear picture of the financial goals of this investment. Do you have a constraint on the monthly housing budget? Are you seeking the lowest overall cost of ownership? How long will you be in the loan? Without answering these and other questions, you can naively lose money on your home refinance.
Here are some of the common traps:
Fall for the monthly savings seduction
Many mortgage brokers or loan officers will push a loan that lowers the monthly mortgage payment. A lower payment might be your goal, but it could come with an overall increased cost. Your total refinance cost will be based on your outstanding loan amount, interest rate, loan term, and cost of executing the loan. Extending the term of the loan will have a dramatic effect on the monthly payment. However, borrowing any amount for a longer term will increase your total interest payments (all else being equal). You can even achieve a lower monthly payment with a longer term and a higher interest rate. Don’t be seduced by a lower monthly payment if it is not required by your financial goals.
Accept the “no cost loan” lie
Loan officers may also promote a “no cost loan”. Be assured that there is no free lunch. A refinance takes effort and someone needs to get paid for the work. That effort is hidden in a higher interest rate. Each loan institution has different rates, different costs and different ways of recognizing those costs. It is actually possible to pay some loan costs, receive a lower rate, and achieve a lower overall cost of the loan.
Don’t look at the total cost of the loan
Your mortgage refinance is an investment decision. You should compare the before and after financial results before making this important decision. A new loan will mean new fees (title, doc fees, inspection, etc.) and a new cost of execution. It will also “reset the clock” on the loan. Fixed payment loans are constructed such that the initial payments are mostly interest and the final payments are mostly principal. The effective interest rate of your existing loan could be well below what you receive from a new loan. Refinancing may not make economic sense. You can only make the determination by comparing the total future costs of the existing loan to the total costs of the new loan. Your loan officer should be able to show you the total cost of both investments before you make the decision, not as you sign the papers.
Ignore the length of time you will have the loan
You may make a loan for 10, 20 or even 30 years knowing full well that you will only be in the house for fewer years. Your investment decision should be based on your financial goals and the total cost during the true expected duration of the loan. Your loan officer should be able to show you a comparison of the total cost of the loan only for the expected duration. Different terms lengths will affect both the interest paid and the accumulation of principal. These factors could be more or less advantageous depending on your financial goals.
Forget to examine ALL the options
A bank is limited to its own offerings. A mortgage broker can match your financial goals and your credit worthiness to multiple offerings from scores of banks and other institutions. A number-crunching mortgage broker can help you calculate the returns of these offerings. (See HERE for an example of this analysis.) An experienced mortgage broker can offer even more options to meet your need. If the monthly budget is not a factor, perhaps it makes sense to increase the monthly payment. This could include making extra payments on the existing loan. A financially astute mortgage broker can interpret the analysis of each of these scenarios for “regular people” and help show which option best meets the individual’s financial goals.
Andre Hemmersbach is an experienced, number-crunching, financially astute mortgage broker. Contact him HERE to find out if a refinance scenario is right for you.