The process of deciding whether to refinance a mortgage in order to lower costs involves four steps:
- Step one: Select the preferred type of new mortgage.
- Step two: Find the best available price on that mortgage.
- Step three: Determine whether the cost of the new mortgage will be lower than the cost of retaining the current mortgage.
- Step four: Find a way to prevent being overcharged after committing to the transaction.
Because borrowers navigating these steps must access multiple sources of information, many of which are unreliable if not biased, it is hardly surprising that many bad decisions are made.
The most important of the bad decisions are those not to refinance by many who would profit from doing so. I have written about this several times, most recently in “4 refinance myths debunked.” Among those who do refinance, the most common mistakes are in selecting the wrong type of new mortgage and then overpaying for it.
Common approaches to step one: Borrowers usually select the type of new mortgage they prefer from among the multiple versions of fixed- and adjustable-rate products that are available, before the refinance process begins; for example, they decide they want to replace their current 30-year fixed-rate mortgage (FRM) with another 30-year FRM. This means that their selection ignores price relationships between the different mortgage types. Sometimes this approach makes sense, but all too often it doesn’t.