Lower interest rates and terms that pay down a loan more quickly are popular reasons to refinance a home mortgage. However, before refinancing, you should know that sometimes you may end up paying more, not less, for a mortgage. Lenders charge new types of fees, and loan arrangements can be complex.
When to refinance
If you’re planning to live in a house more than five years and don’t expect a significant salary increase, moving from a higher interest rate to a lower one or changing from an adjustable interest rate to a fixed-interest-rate mortgage could be worth considering.
For homeowners planning to stay in their homes for more than five years (or those who can look forward to big salary increases), spending the money to refinance may not be the wisest choice.
Adjustable-rate mortgages (ARMs)
If you buy a home and do not plan to stay in the home for more than five years, you might want to consider an adjustable-interest-rate mortgage.
First-year payments on ARMs generally cost much lower than conventional fixed-rate mortgages, as long as interest rates stay reasonable. The fear that interest rates could rise, causing your monthly mortgage payments to rise, can be partially offset by taking an adjustable-rate mortgage with annual and overall limits on rate increases.
If you choose an ARM, ensure you see the limits spelled out clearly in the mortgage contract. In addition, check to see if there’s an interest floor. Some ARMs do not decrease if interest rates drop. Before signing the agreement, check that mortgage rates will be reduced if interest rates drop.
Hidden costs
Before refinancing, figure out exactly how much it will cost you. The advertised interest rate seldom tells the whole story. Additional charges and fees can raise the cost of refinancing to as much as 20 percent.
The biggest refinancing expense is prepaid interest, called discount points. It’s typical for discount points to be 1 to 3 percent of the requested loan amount, but they can go as high as 10 percent. When comparing interest rates, always include this cost. A low-interest loan with high points can easily cost more than a higher-interest loan with lower points. Ideally, refinancing would cost 0 points.
The mortgage company’s refinancing fees can also be expensive. Some lenders charge a flat application fee while others charge a percentage. Those that charge a percent of the loan generally charge between 2 and 4 percent. Therefore, a 2 percent application fee for a $100,000 loan would be $2,000. With a nonrefundable fee, you stand to lose a substantial amount of money if the mortgage refinancing isn’t approved. In addition, closing costs can vary dramatically between lenders. If possible, do not roll these fees into the loan. By doing so, you will be paying for them over the duration of the loan. Pay for these fees out-of-pocket.
More refinancing cautions
These four primary issues offer clarification before you sign a refinancing contract:
1. Negative amortization of an adjustable loan. This can be devastating when you decide to sell the house. If your mortgage rates remain fixed but the interest rate rises, less of your monthly payment is used to pay off the principal. If rates rise a lot, the higher interest due adds to the principal. Then, when you sell the house, you might end up owing the mortgage company more than originally borrowed.
2. Change in mortgage collection company. If your mortgage company sells your loan to another lender, there’s a chance the new company will send a payment book automatically. So, you begin making payments to your new lender, instead of the originator of the loan. However, be sure the originator has “signed-off” or else you may be perceived as defaulting on the original loan. If you see any change in your mortgage processing, contact your originator immediately for an explanation in writing.
3. Private mortgage insurance. You generally only need this insurance when you make down payments of less than 20 percent on a property. Charges usually amount to .5 to 2 percent initially and then .33 to 2 percent annually. To prevent this expense, be sure you refinance 80 percent or less of the appraised value of the house.
4. Prepayment penalties. This expense will show up when you sell your home. A prepayment penalty means that when you sell you will have to pay three to six months’ worth of interest before you close the deal. If you have a prepayment penalty in your refinancing agreement and move in five years or less, all your profits from the sale of the house could be dissolved by a prepayment penalty.
Many homeowners become anxious to refinance their home mortgages to capitalize on any savings. However, before finalizing any refinancing agreement, be sure you know the total amount that you will be paying for the refinancing, how much the new mortgage will cost you monthly, and how much it will cost over the length of the loan.
Once you close on your refinancing, it’s natural to want to make home improvements with the money you’re saving. A personal loan from AdelFi offers the financial flexibility to make that happen in a responsible way. It’s also a way to pay for other big life moments in terms up to 60 months.
As a biblically based financial institution, AdelFi can help you practice responsible stewardship in other financial areas while only supporting organizations that align with your values. With easy-to-use digital solutions, we serve believers throughout the U.S. and those serving in more than 130 countries.
This article has been adapted for use by AdelFi for the benefit of its audience and in exclusive partnership with Crown Financial Ministries. This article was originally written by Chuck Bentley, CEO of Crown Financial Ministries and was posted to Crown.org. To learn more about Crown’s mission go to crown.org.
