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Avoid This Costly Refinancing Trap

August 04, 2016 at 12:00 AM

In late July, the 3.4% average rate for a 30-year mortgage was near the historic low set in 2013. That’s great news for so many homeowners who were unable to refinance back in 2013 because they didn’t have the 20% equity that most lenders require for the best refi deals. Fast-forward to today and home values are up an average of nearly 30% since early 2013. That means plenty of homeowners can now-finally-refinance at today’s great rates.

And even if you refinanced within the past five years you might want to take another look at refinancing (again), if 3.4% is at least one percentage point below your current rate.

But I want all refinancers to be very careful.

Rule 1: Refinance Only If you Intend to Stay in the House a Few Years. There is no such thing as a free refinance. You will either pay closing costs-which can be a few percentage points of your loan cost-or a higher interest rate. You can use an online refinancing calculator to estimate how long it will take for a refinance to pay for itself. Typically that’s at least a few years.

Rule 2: Don’t Extend your Mortgage Term. If your current mortgage is for 30 years and you’re 13 years into paying it off, I don’t want you taking on a new 30-year mortgage with the intention of using all 30 years to repay the loan. That would mean you’d be paying off the home—with interest!- for a total of 43 years.

I want you to look into a mortgage that gets you as close to a total payback of 30 years as possible. Many lenders won’t custom-tailor a mortgage term. In that instance, take out a new 30-year but have the lender immediately send you a schedule of what your extra monthly principal payments would need to be to have the loan paid off within your desired time frame. For example, if you have already made 13 years of payments, ask for an amortization schedule to have the loan paid off in 17 years.

Rule 3: Check Out the Amazing 15-Year Deal. As good as a 3.4% fixed rate for 30 years is, the 2.7% rate on a 15-year loan is well worth checking out. The rate is so low, that you may be able to refinance your remaining balance and end up with a payment that is not much different than what you were paying on your 30-year. The payoff is that you will save on interest payments. A 15-year mortgage can be a great for pre-retirees, as it will help you get the debt paid off before you retire. Another option to build in some breathing room is to opt for the 30-year but ask for an amortization schedule that shows how much you need to pay off the mortgage in 15 years. While your interest rate will be higher than with an actual 15-year loan, you have the option to not make those higher payments if your financial situation changes.

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