"Dos" and "Don'ts" of Refinancing Your Mortgage

I know one of my more controversial hot-takes is that buying a house is not for everyone. A mortgage is a big financial ball-and-chain that I don’t recommend to all readers. But I will say one awesome thing about a mortgage is that you can refinance if interest rates go down.

Let’s rewind. What does refinancing actually mean, in non-jargon-y terms? Here’s the Nictionary definition: Refinancing is the process of transferring debt from a high-rate loan to a lower-rate loan. It’s like switching from an overpriced cable service to something more manageable if you have the opportunity to do so. You still have to pay, but it’s not nearly as pricey. A big reason for doing this is to have a little more cash readily available by reducing your monthly bills.

Not everyone can refinance, though. You have to have a good payment and credit history. But if you are able to do it, here are the “Do’s” and “Don’ts” of refinancing a mortgage:

DO interview lenders like you would a doctor or lawyer whom you plan to use. Not all lenders’ programs are the same and not all fees are the same. Ask these basic questions of all of them:

• Which refinancing options are available for me? And what would an estimate of my monthly payments be in those scenarios?

• What are the upfront costs?

• What are the fees for appraisals, credit checks, escrow and anything else associated with my mortgage?

DON’T be unrealistic about the value of your home; it just stalls the process. And I hope this goes without saying but don’t lead the appraiser on, ever. Just like you wouldn’t tell someone on a first-date that you’re the manager of your team if you haven’t quite gotten that promotion yet— even if you feel like a promotion is all but in-the-bag, that little white lie will bite you in the ass. The same thing will happen with an appraiser. If you have upgrades or improvements to do on your house that would increase its value, do them before you start the refinancing process; don’t promise the appraiser fixes that haven’t happened yet.

DO ask if you have to pay a prepayment penalty for paying your current loan off early.

DON’T go for a “float down,” which lets you take advantage of a lower rate if interest rates fall by the time the refinance goes through (30-60 days). It’s a good option to have when buying the home but a “lock-in,” which rate-locks whatever you had agreed to even if rates go up, is usually what you need in a refinance. If rates happen to go down a significant amount and you want to take advantage of that, you can always cancel the refinance and go elsewhere and start over. The original lender probably won’t be stoked, but…

DO understand and calculate your break-even point. It gives you an estimate of how much time it will take to recoup the costs of the refinance to start seeing any difference/benefit to you. For example, if you paid $5,000 in closing costs and save 100 bucks/month from refinancing, it would take you 50 months (more than four years) to break even.

DON’T blindly accept what your lender comes back with. Look closely at both the rate (this is usually the biggest focus) and the term. Calculate whether the new package actually helps you before you sign. Generally, you should knock at least 75 basis points off your rate to make a refinance worthwhile. More expensive homes can justify smaller rate reductions because the savings are so much greater.

One final tip: DO get addicted to negotiating, but DON’T get addicted to refinancing. I’ve seen people do it too often to try and chase rates lower and lower without accounting for the 3-6% of the loan balance they will have in closing costs. If you refinance too often your costs will build up and bloat your principal balance to a point where you’re not actually helping yourself financially — not to mention that you’re expending a ton of time (and causing a lot of headaches). While I am always a proponent of doing your homework and being proactive, compulsively chasing down interest rates also comes with opportunity costs. I’d rather have you refinance once, the right way, and then spend the rest of your extra time on making smart investment decisions — and more money.

xo,