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For the last year mortgage rates have been favorable and many borrowers have felt that they can refinance their old mortgage at a new and lower rate and come out on top by saving on the interest. The fact is that what you see is not always what you get and managing a mortgage can be tricky. Here we offer a few observations and recommendations that can help prevent a financial mistake that could cost you money instead of create a savings.

Make Sure the Timing Is Right for a Refinancing of Your Mortgage Loan

Borrowers can bring down their cost through refinancing if they are able to recoup the associated costs with refinancing in a short period of time relative to how long they expect to keep their property. If a borrower feels that they can recoup their refinancing costs in a period of two or three years, and would not be selling the financed property in less than five years, the scenario will most likely be a good one.

Jack Guttentag, professor emeritus of finance at the Wharton School, believes that many homeowners are reluctant to refinance because of some basic misconceptions that hold them back. Many feel that they will be losing something because they erroneously believe that if they refinance their mortgage loan that they're losing something by starting from the beginning. Guttentag insists that they aren’t. They begin a fresh mortgage with the balance remaining on the existing one, and while the term for the newer one will go beyond the time remaining on the existing mortgage, it’s easy to keep on the original timetable if they boost their payment by the amount needed to satisfy the new loan in the period that was left on the existing loan

When Is a Bad Time to Refinance a Mortgage Loan

Just because you may be able to get a 30-year loan refinanced for a lower rate, let’s say 4.5% instead of 6.25%, does not mean you will save anything. On the contrary you will lose. The reason for this is that a borrower is essentially lengthening the term of the loan because whatever the remaining time period is, they will be tacking another 30 years onto to that and the borrower is then paying back the loan more slowly for the full term of the refinanced loan. So overall, it’s a no win situation for the borrower and bonus for the lender.

Do Not Make the Mistake of Getting Complacent About the Rate of Your ARM

Adjustable Rate Mortgages (ARMs), for those who were blind-sided by the current state of the housing market, may not be as good looking as they were when they were applied for. Borrowers who have ARMs have been fortunate that their payments have decreased as the interest rates have decreased. This financial holiday will not last forever however and at some point the rates will jump back up to higher levels when the time arrives for their rates to reset. 

Because their ARM has a specific period where the rate is fixed, known as the initial rate period, and that it may change based on movements in an interest-rate index, borrowers need to remain vigilant and know where they stand to avoid any surprises in rate increases. Financial experts advise borrowers with ARMs, who are now staying in their homes longer than they planned to, to look into refinancing before the rates reset at the higher levels when they do return. Being aware of the current rates and being pragmatic can save a borrower interest payments and possibly help to shorten the term of the loan as well.

Prepaying the Principal Can Also Create a Better ROI

Prepaying a loan should be viewed as an investment in many cases. If a borrower has savings, or another asset that is simply earning them one or two percent they should consider using those funds to pay down their mortgage loan principal. In many cases the ROI (return on investment) could be equal or more to the small amount of interest they may be getting from the other asset.

If a borrower has a 6.5% interest on their mortgage loan, and they take the funds that are only earning one or two percent, in use them to prepay their mortgage ostensibly that money will then be earning 6.5% and not the smaller amount earned from a savings account or CD. The other benefit is that paying down principal is risk free.

People who choose to prepay their loans will also be able to get out from under their PMI (private mortgage insurance) faster. Property values have declined in most regions and this has created a loss of equity for many homeowners. If a borrower has less than 20% equity in their property they are most likely required to have PMI. By paying down the principal, and creating more equity faster, a borrower will eliminate the PMI and save.

Borrowers wishing to refinance should always consult with a real estate and loan professional to make sure they are making the right choices. What may appear to be a savings in the long-term may not be. Loan modifications often require appraisals and other fees that can accumulate and diminish the perceived savings and in some cases there are steep penalties for prepayment.

Act, but do it with caution and knowledge on our side.

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