A friend of mine just refinanced his house. And he's not happy.
You'd think that someone who lowered his interest rate by more than 1.5 percentage points and dropped his loan term to 15 from 30 years with a fixed-rate mortgage would be ecstatic. But he's not. In fact, he feels like he got a raw deal. But they were self-inflicted wounds; he made some classic mistakes when refinancing his house, and it cost him a lot of money in the end.
Here are some of his missteps, and what we can learn from them:
1. Not Shopping Around for the Best Quote
The biggest mistake that most mortgage applicants make is not shopping around for multiple quotes. My friend simply applied to one mortgage company without checking around to see if he could find a better deal.
That locked him into a bad deal he later regretted. You have to shop around to not only get the best interest rate but also the best terms for your loan, whether you're applying for a traditional mortgage or refinancing.
My friend's error here stemmed from a misunderstanding about how credit agencies operate: He thought that shopping around with multiple mortgage companies would harm his credit score. What he didn't realize was that credit bureaus like the Fair Isaac Corp. (FICO), the creators of the popular FICO credit score, understand that consumers will -- and should -- shop around.
A "hard pull" of your credit score for a new mortgage application and taking on new debt will slightly lower your credit score. But FICO treats it as only one pull of your credit score if you shop around and apply and receive multiple bids for the same loan in a short time period.
2. Accepting a Long Escrow with a Non-Adjustable Rate
When my wife and I closed on our first home, our mortgage lender offered us a one-time deal to change our rate if the available interest rate for our loan decreased. Banks peg mortgage rates against many factors, such as the LIBOR rate, supply and demand, and other factors, and they fluctuate constantly.
The mortgage company originally required my friend to pay a point on top of his closing costs for his refi. While he was waiting for the approval process to play out, the market shifted. Now his bank offers customers the same refinance mortgage for better terms and no points paid up front.
But the mortgage company wouldn't let him change his refinance application. He's locked into the contract with the less beneficial rate. If he had shopped around and not settled for the first loan offer that was made to him, he could've probably gotten one with a clause allowing him some wiggle room to change if the rates moved before he closed.
Now he's stuck with a less than optimal loan. The difference will cost him more than $1,000 in fees.
3. Settling for the Lender's Appraiser
My friend also used the lender's in-house appraiser -- a mistake.
You should have the option to choose your own appraiser, real estate attorney, survey company, and other professionals to help you close on your home. My friend used the lender's attorney for closing, as well. This is a big red flag.
4. Not Understanding His Rights to Rescind a Mortgage
Most states have a lemon law clause when you buy a car. You can return it and walk away from the deal within the first three days if you're not happy. Refinanced mortgages often have a return policy, as well, if the borrower has second thoughts. Consumers have rights under the Truth In Lending Act (TILA), which allows them to rescind a mortgage deal under certain circumstances.
As with cars, borrowers refinancing their mortgages have the right to void a deal within three days of their closing if they meet certain conditions. It must be a refinanced mortgage. And you can't be refinancing with your current mortgage company.
Rescinding a refinanced mortgage might be the nuclear bomb reaction to a mortgage gone badly before closing. Borrowers should use it as a last resort. Consumers can prevent falling into a bad refinance deal, which is easier than getting out of one after signing on the dotted line.