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5 dumb refinance mistakes

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When refinancing a mortgage, smart people can do stupid things. But smart people can also get informed and avoid costly errors. Here are five stupid refinance mistakes and the smart ways to avoid them.

1. Assuming your home's value hasn't dropped

Why it happens: Homeowners especially can be over-optimistic (even delusional) about home values.

A recent study concluded that homeowners consistently overestimate the value of their property by 5 to 10 percent, and those who bought at the height of the market are most likely to make this error. Even in neighborhoods where every third home is in foreclosure, some residents don't see the connection between their neighbors' home equity erosion and their own. This causes them to waste money for appraisals when they haven't a snowball's chance in hell of getting a refinance.

How to avoid it: You can handle the truth! Check several online valuation systems to get a possible range of values for your home. Request the opinion of a real estate agent who sells a lot of homes in your neighborhood. When considering a refinance, know what value you need to conclude the transaction and then determine how likely your home is to appraise at that value.

2. Refinancing with your current lender without rate shopping

Why it happens: Because we're slackers when it comes to not-fun things like mortgage shopping.

Retention strategies are programs designed to recapture customers considering a refinance without putting silly ideas into the pretty little heads of other customers. Inquiring about your mortgage balance can trigger a call and a refinance offer from your lender. It can tempt you to take a higher-than-market mortgage rate by making it easy with a preapproved or streamlined process.

How to avoid it: Your lender is not your friend--don't assume that it's giving you a special deal. Compare your lender's quote with others--see what rate you'd qualify for at the same costs as your lender's offer, and get these quotes in writing. If you can do better elsewhere, inform your lender and you may be offered a better deal--or refinance elsewhere for a lower rate.

3. Skipping your mortgage payment during escrow

Why it happens: We hear what we want to hear.

Well-intentioned advisors like this guy who recommends applying for a refinance, skipping your payment, and spending it on Christmas gifts(!), can make you think that there is some kind of fabulous free lunch associated with mortgage refinancing. However, if your new loan closes late, the missing payment could end up on your credit report and even increase your refinance rate. That could give you a nasty case of indigestion.

How to avoid it: Make your mortgage payment on time (or even early if you don't do it online) each month until your refinance has closed. If you overpay your old lender, the money will be returned to you. Understand that refinance transactions may take longer than purchases because lenders give purchase mortgages priority.

4. Making purchases on credit

Why it happens: Spending money feels awesome! But it shouldn't--Matt Hackett, an underwriting manager with Equity Now, explains.

"Most lenders pull a 'no score report' or a 'soft pull' which does not show credit scores, but shows any updated balances, payments, and/or new accounts which have been opened since the original credit inquiry."

This report can kill a refi.

"If there are new inquiries or accounts, the borrower will have to explain them and the loan will go back to underwriting," says Todd Huettner of Huettner Capital. "At a minimum, this could cause delays. If a new account exists, then it must be documented and the liability must be included in the debt-to-income analysis."

Borrowers' errors can be costly.

"They will save $100 on a new TV if they open a store credit card but wind up paying thousands more on their refinance," says Huettner.

How to avoid it: Certified Mortgage Specialist and author of Stress Free Mortgage Linda Fleischmann says, "I make sure that my clients are very aware of the 'do not apply for new credit' rule as well as having them call me prior to making any large purchases." So hide your credit cards and don't give your Social Security number to anyone until your mortgage refinance is closed and funded and you hear the fat lady singing.

5. Overestimating self-employment income

Why it happens: We equate income with winning and we don't want to be losers. Everyone has a friend who always comes back from Vegas claiming to have "won" thousands. And he did win, if you ignore the losing hands!

New business owners tend to do the same thing, counting the revenue (winning hands) while disregarding expenses. Borrowers who gross $10,000 a month might list that figure on their refinance application, but lenders look at tax returns. Many applicants find that the $10,000 a month they claim in earnings becomes $2,500 a month when mortgage underwriters get through with it.

How to avoid it: Understand how lenders evaluate your income. At its simplest, self-employment income for mortgage lending purposes is your taxable income plus depreciation and home office expenses. Lenders use Fannie Mae form 1084, Cash Flow Analysis, to calculate it.

Before refinancing, make a more realistic estimate of self-employment income and run it through a mortgage prequalification calculator to see if you earn enough to get approved. And know that underwriters don't think you're a loser even if they do cut your income.

So, no matter how smart you are, know that everyone is capable of making a dumb refinance mistake. But if you follow these five rules, you'll have the best shot at a seamless refinance.

About the author:

GinaGina Pogol has been writing about mortgage and finance since 1994. In addition to a decade in mortgage lending, she has worked as a business credit systems consultant for Experian and as an accountant for Deloitte. She graduated with High Distinction from the University of Nevada with a BS in Financial Management.

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