Low interest rates might not be doing your savings account any favors, but they’re a boon to borrowers. You may be able to shrink your monthly payments and pay off debt faster by refinancing your mortgage or car loan at a lower rate, but only if you do it the right way.
Back in 2010, interest on a 30-year fixed-rate mortgage averaged 4.69%. In April 2016, the average rate was 3.61% for a 30-year loan and 2.87% for a 15-year fixed rate loan. Average rates on car loans are also about 1% lower than they were five years ago, according to data from Bankrate.
A difference of just 1% might not sound like a lot, but it can translate into significant savings. Reducing the rate on your $200,000, 30-year mortgage mortgage from 4.5% to 3.5% could save you more than $24,000 over the life of the loan, according to Zillow. You could save more than $1,000 by refinancing a $25,000 auto loan from 5% to 4% and shortening your loan term from 72 to 48 months, according to Nationwide.
Taking advantage of those savings is a big reason people refinance. Others want to shorten or their loan term to pay off debt faster, or shift to a loan with more favorable terms. Some might want to get cash out of their home to pay other expenses. Whatever your motivation for refinancing, you should go into the process with your eyes wide open. Before you head to the bank, make sure you know to avoid these seven refinancing mistakes.
1. Not considering a refi
Refinancing your mortgage or auto loan could save you thousands of dollars, but many people may not think to consider this money-saving move, especially when it comes to cars. While refinancing a mortgage is fairly complicated, refinancing your car loan is usually a quick and painless process, notes Edmunds.com. If your credit score has improved or interest rates have dropped since you bought your vehicle, contact your lender about refinancing, especially if you have a longer-term loan.
2. Being unprepared
You’ve already jumped through all the car loan or mortgage application hoops at least once, so when you refinance, you might be tempted to breeze through some of the details. Rushing the process or taking shortcuts can be a costly and time-consuming financial mistake.
Before you head to the bank, make sure you’re up to date on your credit score, current interest rates, and your home’s value (if refinancing a mortgage). You’ll have a better idea of what to expect when you sit down with the loan officer and will know if you’re getting a good deal or not. Now is also a good time to reassess your monthly budget to decide if you can afford higher monthly payments if you’re planning to switch to a loan with a shorter term. For a mortgage refinance, you’ll also need pay stubs, W2s, tax returns, information about your debt and investments, and other financial documentation. You can reduce refinance headaches by having all those documents organized beforehand.
3. Running up debt before you apply
The better your credit score, the better rate you’ll get on your new mortgage or car loan. If you’re considering a refi, hold off on making big purchases on credit and don’t open a bunch of new credit accounts. Both moves can ding your credit score, which means you won’t get as favorable of a rate when you refinance.
“Don’t buy a new car, make other major purchases or fill out multiple credit applications before you refinance, because all of those actions can hurt your credit profile,” Michael Smith, first vice president – business development manager for mortgage lending at California Bank and Trust in San Diego, told HSH.com.
4. Not shopping around
Your current lender may be teasing you with sweet refinance deals, but you should shop around before you sign on the dotted line, since going with another bank may save you money. Even if you’re happy with your bank, presenting competing offers can be a useful negotiating tactic when discussing a refinance.
Start by determining what kind of loan you’re looking for (e.g., a 15-year or 30-year fixed-rate mortgage), then contact a few lenders and get information about rates, fees and loan terms. Compare offers from several different lenders before making a decision, the FTC advises.
5. Focusing only on the rate, not the loan term
Scoring a lower interest rate is the prime objective for most people looking to refinance, but you shouldn’t overlook the opportunity to change the length of your loan term. Not only will you pay less in interest on a shorter-term loan, you’ll also pay off your debt sooner. If you have the wiggle room in your budget to cope with a shorter payoff period, it might be wise to opt for the 15-year mortgage rather than the 30-year one.
Shorter-term loans aren’t right for everyone, however. If you’re paying down other debt or focusing on retirement savings, throwing more money at your mortgage may not be worth it. While you’ll be in debt longer with a 30-year mortgage than a 15-year loan, the lower monthly payments give you more financial flexibility. The right choice depends on your specific financial situation and goals.
6. Overlooking extra expenses
Refinancing isn’t free. You should expect to pay between 3% to 6% of your outstanding principal when refinancing, according the Federal Reserve. Those costs include loan application, loan origination, appraisal, and inspection fees, as well as fees for attorneys, title searches, and mortgage points to reduce your interest rate. Some mortgages and car loans also come with a prepayment penalty, which means you’ll pay a fee if you pay off the debt early.
Before refinancing, consider how long it will take you break even after paying any extra costs. Say your new mortgage will save you $150 a month, but you have to spend $3,000 in closing costs and fees. It will take 20 months until your new loan really starts saving you money.
7. Assuming a “no-cost” refinance is better
If your lender is offering you a “no-cost” refinance, make sure you understand the terms. No-cost likely means the lender either bundles the various fees into your principal or charges you a higher interest rate in exchange for not requiring you to put up cash to cover the closing costs. Unless you don’t have the money to cover the closing costs or only plan to live in your home for a few years, the traditional refinance is likely a better option, according to Bankrate.