Refinance Risks 101: What You Should Know Before You Start the Process

With low interest rates and a sluggish economy, many homeowners may be considering refinancing as an alternative to buying a new home. Nationwide, homeowners stand to save money and pay less interest by taking advantage of low interest rates. However, refinancing has a few risks for borrowers that range from paying too much to losing the home completely. Here are a few hazards to watch if you’re considering a mortgage refinance. Penalties On some mortgages, a clause stipulates that the property can’t be refinanced without a penalty. In some cases, this penalty can be fairly high, especially with unsavory lenders. Before pursuing a refinance option, read over your mortgage for this type of language. Before signing the paperwork on your refinance, make sure the lender charges no fee for an early payoff or future refinance. Foreclosure Protection In some states, homestead protection safeguards a home from creditors and tax collectors if a spouse should die. Depending on the laws in your state, refinancing may remove this protection since your home is now classified differently than on the original mortgage. Before refinancing, check the laws in your state to see if refinanced homes have the same protection as original mortgages. High Closing Costs The average adult will move 9.1 times in his or her life, according to the U.S. Census Bureau. Because of this high mobility, the small savings a homeowner can enjoy when interest rates drop may be negated by high closing costs. At closing, you should expect to pay thousands of dollars in appraisal, application, loan-origination, and home-inspection fees. These costs can often be rolled into your monthly mortgage payment, but they can completely eliminate any financial benefit you would get from refinancing at a lower interest rate. Need for Longevity Experts generally recommend refinancing only if you plan to remain in the home for a while. If you pay all of those closing costs, only to put your home on the market a couple of years down the road, your cost savings won’t be worth it. If a prepayment penalty will apply to the home, you should plan to remain in the home for the duration of the penalty period. This can stifle a homeowner who might have otherwise been able to move without this additional financial burden. Your Payoff Will Be Later If you dream of the day when you’ll make your final payment on your home, refinancing isn’t for you. The day you sign on the dotted line, your mortgage will start over at day one. Not only does this mean your payoff date will be 15 or 30 days into the future, but it also means you’ll be paying very little on the principal for the first few years, just as you did in the first years of your original loan. This doesn’t apply if you’re refinancing your loan from a 30-year to a 15-year loan. If you see a refinance in your near future, these factors can seriously impact the benefits you’ll achieve. Learn as much as possible about your existing mortgage, as well as the new mortgage you’ll be signing, to avoid any hidden pitfalls.