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The Art of Refinancing: Avoid the Most Common Errors

With interest rates being at their lowest levels in decades, many homeowners are exploring the option of refinancing their current home mortgage loan.

Whether you secure a loan with a new mortgage company or with the same lender who has your current loan, you have to start all over again. This means that you will have to fill out an application, have your home appraised, obtain an updated title report, and pay closing costs. Refinancing is a brand new loan and therefore will be treated as one. The only difference is that there won't be a buyer/seller situation.

Just as you did with your original mortgage, you should shop around for the best rate. Determine what your finances can handle: a 15-year or 30-year loan.

In recent years, many homeowners purchased homes with an Adjustable Rate Mortgage (ARM). With these loans, the interest rate most often changes annually, although some change only every three years. When you look at refinancing, you should look into getting a Fixed Rate Mortgage (FRM) that will lock you into a non-changing loan. In other words, your payments will remain the same over the life of the loan.

Make sure you look at all the costs involved with refinancing. There could be additional fees for underwriter fees, a title search, title insurance, etc.

Next, find out if your lender will be charging you any up-front points. Remember that each point is equal to one percent of the loan amount. If you were to borrow $100,000, each point would cost you $1,000.

Work with your lender to determine the amortization so you know exactly what your monthly payments will be. A number of good mortgage loan calculators are available online, which will allow you to calculate your down payment, monthly payment, payoff, etc.

If you plan to stay in your house for some time, it makes more sense to go with a lower interest rate and add the point or points you need to pay on the new loan. Keep in mind that points on refinance loans are usually not tax deductible unless the purpose of the loan is to pay off improvements made to the house.

Although there is no guarantee as to what the future will bring, analysts predict that interest rates will begin to creep back up. As the economy starts to recover, interest rates will also re-establish at a higher rate.

Locking into a 30-year fixed rate at a lower interest rate has a lot of merit and is a great consideration.

On the other hand, if you don't plan to stay in your home more than three years, and you can lock into an adjustable rate for less than 6%, it may make more sense to go this route. Over the three-year period, the rising interest rate from the ARM will likely not be enough to be worried about.

If you are not sure which way to go, sit down with several lenders as well as a financial advisor and have them review the figures with you. Keep in mind that not all refinance programs are the same. They will vary from one lender to the next, so look around.

It's never too late to refinance. However, a standard rule is that anytime the interest rates drops 2% or more from your original interest rate, you should refinance. A difference of 2% could save you around $200 a month, or $2,400 a year. That's definitely worth considering.

There are many different reasons for refinancing a house. Lower interest rates are just one of them. Other reasons might include going through a divorce, education needs, or debt consolidation (getting credit cards and other bills paid off).

Just as with your first mortgage, when you refinance, you need to stay in your home long enough for the new mortgage to pay off as far as up-front costs to process the refinance. This would include settlement charges, application fees, points, credit report fees, title insurance, etc. All these costs would be added into the new loan, so determine how long it will take to pay off all of these fees.