As interest rates hover at record low rates more Americans are realizing significant savings by refinancing their home mortgages. While it is exciting to see your monthly payment drop, borrowers must be careful to select the best possible product for their needs while avoiding several potential pitfalls.
Choosing a Refinancing Loan Product
First, you must choose the type of mortgage you need. The thirty year fixed rate remains popular and is well suited to most borrowers. Other products can vary in length such as 10, 15, and 40 year mortgages. Another type of mortgage is the adjustable rate. They are typically described with two numbers, the initial fixed period, followed by the frequency of adjustment. For example, a 5/1 mortgage indicates a fixed interest rate for five years, followed by adjustments every year. Borrowers should be very cautious when selecting an adjustable rate mortgage as their terms virtually guarantee that payments will rise after the initial fixed period. Therefore, adjustable rate products are best for borrowers who plan on moving or refinancing before the fixed rate period expires.
Choosing a Mortgage Lender
Once you have selected a type of product, you will then need to select a company that offers the best rate. There are many sites online that will allow you to compare the rates offered by different companies. A key component in the rate are the fees charged. The greater the fees, the lower the rate will be. Possible fees included “points,” each one of which represents a single percentage of the loan amount that the borrower must pay. Other closing fees include lender fees such as origination, administration, and processing. Finally, a lender will ask borrowers to pay for third party fees, such as appraisal, courier, and title registration. Some or all of these fees may be paid by the lender, but this will result in a less favorable interest rate. It is up to the borrower to determine whether or not the additional fees are worth the lower rate.
Homeowners can also take cash out, by borrowing more than they owe. This is tempting, but not recommended as it will raise your payment and amount to negative savings account. When choosing a lender, rates may not be the only criteria. Borrowers much take into account the reputation of the lender in order to ensure that the loan closes smoothly. Wise borrowers will investigate their loan originator in order to determine if they have a track record of poor customer service.
Other Mortgage Factors to Watch Out For
Borrowers should avoid loans that contain pre-payment penalties. While illegal in many states, these loans impose massive fees on homeowners that wish to refinance or sell their home. Another type of mortgage that should be avoided is one that requires interest payments only. These interest only products defeat the entire purpose of a mortgage, to build equity while paying off the loan. By exempting borrowers from contributing to principal, homeowners are little more than renters.
Along with purchasing a home, refinancing is likely to be the largest single transaction that most homeowners will ever complete. By finding the best products and rates, and steering clear of potential pitfalls, homeowners can walk away from this process with the best mortgage for their needs.
Jason D. Steele is personal finance writer and a consumer advocate.
Photo by James Thompson via Flickr