According to a report by CNN, the 30-year mortgage rates continued to drop reaching an all-time low of 3.93%. It is, therefore, no surprise that a good number of homeowners are opting to cash-out their mortgages for them to enjoy the low rates.
However, the refinancing can be very intimidating, especially if you do not know the best way to go about it. What you want is to trade in the current mortgage for a new one that will help you reduce the rate, while at the same time helping you build equity fast.
The best way to refinance your home loan is to first take your time and to know how to go about it and not just to grab the first opportunity that comes your way. You need to know the mistakes to avoid and how to avoid them.
What Is Cash-Out Refinancing?
Simply put, a cash-out is trading in your current home loan for a new one that is better in one way or another. There are several reasons to refinance your mortgage. You can choose to refinance to lower the amount you pay on interest rates, to get some cash, or to reduce your payment term, for example, reduce a 40-year loan to a 20 year one.
When you are ready to refinance a home, there are several mistakes that you should completely avoid. Here are some:
1. Failing to Shop Around
When refinancing a mortgage, you do not have to go to your current lender, your bank, or the overly advertised lender. Take your time to shop around and check out your current lenders’ competition and see what they have to offer.
You can be amazed at the different rates you get. The goal here is to get only the lender with the lowest interest rates. Even the slightest difference can mean a huge saving. It pays to look into each lenders rates to get the best deal possible.
2. Not Saving Enough
A small reduction in your current interest rate will mean that you will take a longer period to clear your debt. This is also known as breaking even. You should clear a good percentage of the going rate to make a refinance worthwhile.
If you have a high-end home, it can warrant a smaller rate reduction when compared to a modestly priced home. This is because the savings are greater. A small reduction is also good if you plan on staying in that home for a long time.
3. Focusing on the Mortgage Rate
Even though you want the lowest rate possible, do not make your decision based only on it. Several factors are considered when pricing a mortgage and a low rate from one lender can cost more than a higher rate from another.
Ask about credit reports, points, loans original fees, and all other charges before settling for that lender. You might not get to know some fees till you get your good faith estimate after applying for the loan. However, major changes will mean that something is not right.
4. Refinancing Too Much
It is very tempting to refinance your home for a second or third time given the current mortgage rates. This can very well land you in trouble if you do not proceed with caution. Refinancing costs money; you will have to pay a percentage of the loan’s closing cost.
In order to opt for refinancing, you should have enough money in interest to cover the closing costs. Otherwise, you will only end up piling up the closing costs over time and this will increase your loan balance. This practice rules out the benefits of refinancing.
5. Timing Mortgage Rates
Homeowners have the habit of clearly following the changes in refinance rates to grab the opportunity the minute the rates are at their lowest. You might end up missing it and only see the rates going up again.
This can be compared to trying to time the stock market. It is not easy, even for the professionals. The truth is, mortgage rates are low compared to the past, and timing it to go lower is simply greed and you might lose the perfect opportunity to refinance your loan.
6. Not Checking Your Loan to Value Ratio (LTV) or Debt to Income Ratio (DTI)
Say you want to borrow $80,000 and your home is estimated to be worth $100,000, your LTV is 80%. Having a high LTV should not deter you from refinancing, you might have to buy mortgage premium insurance. Finding out how much your home is worth is the best first step in determining your LTV.
Your DTI, on the other hand, shows your ability to pay your debts monthly. For example, if your monthly income is $4,000 and you pay $800 on all non-housing loans, your DTI is 20%. The DTI ratio varies with your spending, but with a lot of credit card debt, you might have some challenges when you want to refinance.
7. Too Much Home Equity Cash-Out
Homeowners can opt to use the refinance to borrow some money against their home equity and take out cash for home repairs, major purchases, home upgrades, or any other expenditure. This is ok because it is a tax-deductible and attractive way to borrow money.
The only problem is when you decide to invest too much capital. This can be a risky move in case of a drop in housing prices, leaving no room for error in case you get into a financial crisis. Be very careful when taking a cash-out. Make sure that you leave a good safety net in home equity, typically 20% of the homes equity is considered safe.
8. Failing to Do Your Homework
One of the basic things that you need to do before taking a cash-out is to do your research. Before contacting any lender:
- Know your credit score: this will give you a rough idea of how much you can qualify for. Lenders always ask for such information. It can affect your rate.
- Know the value of your home: talk to a real estate agent to know how much your home is worth. You can also consider having it appraised to have the absolute value and not just the estimated value. For a free option, that is more robust than the Redfin & Zillow searches, click here.
This information will give you an idea of how much you can get from different cash-out lenders. You will know exactly how to negotiate and the type of rate you can get without the need of pulling your credit.
9. Stretching out the Loan
Many buyers are given a 30-year mortgage. This means that by the time you want to cash-out you will have already paid on it for a couple of years. Should you refinance into yet a new 30-year plan, you will be starting all over again. Some lenders offer flex term refinance loans that will allow you to incrementally choose how many years you would like your new loan to be repaid in. For example: you have had your 30 year mortgage for 1 year, refinancing into a 29 year loan, and accomplishing your refinance goal could be the more appealing option if you are savvy to the true cost of amortization.
Even though such an extension can reduce your monthly payment, you might end up paying more interest. This is regardless of having found a lower rate. Remember, you are only spreading the loan balance over a longer period.
Avoid stretching out the loan and refinance to a shorter-term that matches the time left to clear the current mortgage. Extending your loan will only make sense if you are considering debt consolidation. However, you will still end up paying more.
10. Failing to Lock Your Rate
Do not just ride the markets hoping to bump into a lower rate. It can end up costing you more and maybe destroy your hopes for a refinance.
Talk to your lender about their rate lock options. Get to know what it takes and the process involved in it.
It might be wise to lock your rate so as not to risk it going up before you close. It is better to lock a rate for 30 to 60 days.
There are several other things that you should consider when refinancing your home. Bottom line is that with good credit and a lot of equity, you will have such an easy time refinancing your home.
To avoid any delays in your loan application process. Make sure that:
- You have the necessary paperwork and document ready with you
- Indicate any changes in your income in your paperwork
- You have appraised your home in advance so that you avoid dealing disappointments like a low appraisal report once you have started the loan application process.
With all this information at hand, your next step is to proceed and apply for your loan with your preferred lender. Do not forget to be patient, it might take a while depending on the lender.
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