7 common mistakes when refinancing into a low mortgage rate

Mortgage rates are at an all-time low, with those on a 30-year fixed-rate mortgage falling below 3 percent for the first time in 50 years. Record-low refinance rates, accordingly, have opened the doors for many homeowners to want to refinance their existing home loan to reduce their monthly payments, speed up their loan payoff or gain access to their home’s equity.

Before you move forward with a refinance, though, it’s important to know what the common pitfalls are with the process and how to avoid them. Here are some to be aware of.

1. Not shopping around

To ensure you get the lowest rate that you qualify for it’s crucial that you take time to shop around and compare rates from multiple lenders. Even if you’re using a broker, they may be limited to certain lenders.

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2. Focusing only on the rate

A lot of different factors go into determining your mortgage interest rate, and one of those is mortgage points. A lender may offer a lower rate to match or beat a competing offer. But the bank may be charging you more in the form of mortgage points to make it happen.

Also, keep in mind that your credit score is a major factor in determining your rate. So check your credit and consider whether you should work on improving it before you apply.

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3. Not checking all the loan costs

Refinancing your existing mortgage loan involves creating a new loan, so you can expect to pay closing costs. In general, closing costs on a refinance will range from 2 to 6 percent of the loan amount.

You can choose to pay these costs out of pocket or roll them into the new loan. If you’re short on cash, the second option may sound appealing. But keep in mind that you’ll be paying interest on that additional amount for several years.

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4. Cashing out for the wrong reasons

A cash-out refinance allows you to gain access to some of your home’s equity in the form of cash. You can use this money to consolidate debt, buy a divorced spouse out of their stake in the home, make renovations, and more.

But if you use it for unnecessary things like a vacation or to live beyond your means, it could come back to haunt you.

Also, keep in mind that you’ll be limited in how much you can get in a cash-out refinance—typically up to 80 percent of the home value—so check with lenders first to make sure it can even help solve your current problem.

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5. Not calculating your break-even point

If you’re refinancing for a lower interest rate, it’s important to consider how long you plan to remain in the home. That’s especially the case if you’re paying closing costs out of pocket. For example, if a lower rate can save you $120 per month, and the loan’s closing costs are $4,560, it’ll take you 38 months to recoup those costs in the form of monthly savings.

If you’re not planning to stay in the home for that long, refinancing will actually cost you money and likely isn’t worth it. Use an online mortgage refinance calculator to determine your new costs and compare them with the upfront costs of getting the loan.

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6. Extending your mortgage

If you’ve been making payments on your mortgage loan for five years, it may make more sense to refinance into a 25-year loan than a 30-year loan. If you refinance with a longer repayment term, it’ll ultimately cost you more money in interest charges, even with a reduced interest rate, because you’ll be making payments for five additional years.

7. Trying to time mortgage rates

If you’re holding off on refinancing because you want to wait until rates go down further, you may regret it. Trying to time refinance rates is like trying to time the stock market—it’s impossible, and you could end up missing out on a good deal if rates increase instead. If now is the right time to refinance for all of your other reasons, go for it.

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