Q: My Husband and I have a home in his name. If we refinance in both our names next year, When my credit improves, what are the benefits of doing so?
A: If your credit does improve and interest rates remain low, one benefit of refinancing is that you and your husband may qualify for a much lower rate, thereby lowering your monthly mortgage – and possibly saving thousands of dollars in finance charges over the life of your loan. In a refinance done under both of your names, the bank will look at both of your incomes and likely pull a “tri-merged” credit report on each of you, showing your respective credit histories with TransUnion, Equifax, and Experian. The lender will typically use the middle credit score for each of you, and will base your loan rate on the lowest of the two middle scores shown by you and your husband.
Can You Get a Better Deal?
After owning your home for some time, it’s only natural that you might start to consider whether or not you should refinance your mortgage. This is particularly true if interest rates have dropped considerably since you first obtained the home, or if your credit has improved dramatically. In these instances, it’s likely that you will be able to get a much better deal on a new mortgage than your original loan. Before you commit to refinancing, however, make sure you realize the implications of doing so.
Do’s and Don’ts When Refinancing Your Home
To begin with, refinancing can eat away at your home’s equity because refinancing is not free. A refinancing means you take out a completely different mortgage. The refinance process entails paying off your old loan and replacing it with a new one, and banks aren’t in the business of making loans free of charge. Even if you hear lenders talk about a so-called “no cost” refinancing, don’t believe it. A lender might not have an application fee, or charge you points to refinance, but those costs and others associated with refinancing are essentially priced into a loan with a higher interest rate. As you’ve heard many times before, “There’s no such thing as a free lunch.”
Tax Benefits of Your New Mortgage Not as Great
You probably remember that points you pay to obtain a mortgage are tax deductible. When you refinance, however, any points you pay must be amortized over the life of the loan. In other words, you can’t take the full deduction for the points in one year, as you can do when you buy a house.
As with a home equity loan, you should never refinance into a larger loan than is necessary. Unfortunately, scores of homeowners do this all the time when they sign on the dotted line for a “cash out” refinance, which allows you to not only get a better rate or more favorable loan terms, but which also allows you to get some dollars back in the deal as well. A cash out refinancing saps equity from your home, so you should only take that money if you plan to use the proceeds wisely. Guard against frequent refinancing, too. If rates drop a half point or even a full percentage point, do the math to figure out if any monthly savings you can generate will really outweigh the closing costs and other fees associated with a refinance. I can’t help but wonder if many consumers are really just cheating themselves out of the opportunity to build wealth due to excessive refinancing.
Don’t Refinance Your Way Into a Negative Equity Position
Consider these facts: Nearly nine out of 10 consumers who refinance their home loans take cash out in the transaction. In 2006 alone, Americans cashed out $352 billion worth of home equity – more than a 10-fold increase in the amount cashed in the year 2000. Moreover, when the Joint Center for Housing Studies (JCHS) at Harvard released its annual survey of housing, called the “State of the Nation’s Housing 2007,” the results were especially sobering.
The JCHS report indicated that 13% of individuals and families who bought homes in recent years (in 2003 and 2004, to be exact), already have “negative equity” in their homes. This means their outstanding mortgage debt exceeds the market value of the houses in question. Unfortunately, the news is even worse for more recent buyers. A November 2007 survey by Zillow found that nearly 16% of homebuyers who purchased houses in 2006 had negative equity, as did 17.5% of those who bought in 2005. As of early 2010, the number of homeowners facing negative equity has mushroomed to as many as 25% as real estate prices remained soft.
Importance of Comparison Shopping
As with all financial products, you should shop around for the best loan terms you can get in the event you decide to refinance your mortgage. Don’t just accept the first offer that comes your way. In considering a refinancing, follow the same vigilant standards you used to evaluate lenders and their offerings when you bought your house. This means you should know the annual percentage rate on your new loan, all fees charged, as well as key payment terms, such as whether a prepayment penalty exists.
Final Words of Caution
Don’t ever sign any loan documents that you don’t understand and don’t agree if any loan officer or mortgage broker asks you to put your signature on a blank document with the promise that he or she will fill it in later. You don’t know what they could insert into those loan documents. Also, make sure you get copies of everything in connection with a new mortgage, including a Good Faith Estimate, a Truth in Lending form, as well as the mortgage, note, and/or promissory document you must sign.