If you are considering mortgage refinancing then you are probably thinking about savings from a lower interest rate and payments. What you may not be considering is how much you will spend to get that lower mortgage interest rate. Mortgage refinance companies have developed many techniques to downplay the costs of refinancing by flashing incredibly low rates at prospective customers. Before you jump on the mortgage refinance bandwagon, be sure you understand exactly what you will be required to spend to get your new mortgage loan.
Is there really such thing as a No Cost Refinance?
There is no such thing as a “no-cost” refinance. No mortgage lender could stay in business by giving away lower interest rates without any type of return on their investment. What these lenders typically do is advertise no “up front” costs for your mortgage refinance. This means, however, that the costs will be added to the total of your mortgage principal or offset by a higher interest rate. While the extra amount on your payment may not be noticeable, it will become very obvious if you choose to refinance again, or if you choose to pay your mortgage off early. Mortgages are amortized so that the principal is the last thing to be paid; your first payments will be mostly interest. The amount of principal you pay over time will gradually increase. By adding your financing costs to the principal, you are actually paying interest on more money for much longer than if you paid these costs up front.
Always ask for a Breakdown of the Costs – The Good Faith Estimate
If you are considering a mortgage refinance, ask for a breakdown of the costs—not as they are rolled into the loan, but as they are actually calculated. You will probably be surprised at the amount of the “loan fees” and “processing fees” most lenders tack on to the cost of your mortgage—money you might never have noticed if it was rolled into your mortgage principal. It is possible to negotiate these fees with the lender if you agree to pay them up front, and you can easily compare offers from multiple lenders this way. Mortgage lenders are obligated to provide you with a good faith estimate however there are also obligated to do many things they don’t always do.
Consider the Term of the New Mortgage
Another thing to consider is how long you will have your mortgage. If you are refinancing for thirty years, you will pay the maximum amount of interest in this time. Ask the lender to give you projected payments for a 15-, 20-, and 30-year loan scenario. You will be very surprised at how little it costs, relatively speaking, to have a 15-year loan versus a 30-year loan. If the difference is only $100 dollars or so a month, consider that you are saving a full fifteen years of interest by choosing the 15-year loan. It quickly becomes obvious that the shorter the term of your mortgage, the less money you pay.
Interest Rates and Terms of the Loan are Critical
You should also be very careful to understand the terms of the mortgage itself. If you choose an ARM, or adjustable-rate mortgage, with a low introductory rate, you may be unpleasantly surprised in a year or so when the rate suddenly skyrockets. If you are considering an ARM, be sure to ask the lender to put in writing the terms of how much the loan’s interest rate can be increased, and ask for a projected payment in the “worst case scenario.” You should also avoid loans with “balloon payments,” which is simply a fancy way of saying that you avoid paying most of your principal up front, only to be faced with it in a lump-sum payment down the road. Many people have lost their homes due to ARMs and balloon payments.
Staying with a fixed-rate, shorter-term mortgage is usually the best choice from a financial standpoint. However, even fixed-rate loans can have significant hidden costs. If you are required to pay for an appraisal, loan fees, processing fees, and title costs, your closing costs could easily reach thousands of dollars. Further, if you are required to pay “points” on your mortgage, the total closing costs will definitely be significant. Points are percentages of the principal charged up front by the lender, usually in increments of 1%, 3% or 5% (1, 3, or 5 points). This is money that you must come up with to finance the loan, and which you will not get back over the life of the mortgage.
Knowing the hidden fees lenders often tack on to mortgages can help you save significant money over the life of your mortgage. The old rule still applies, and is still true: if it sounds too good to be true, it probably is!
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