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Responsible Refinancing: Tips To Avoid Predatory Lending

Written by Dian Herdiana on 7:30 AM

Homeowners interested in refinancing are probably aware of the dangers of predatory lending. But how do you recognize a predatory lender when you see one? How do you avoid the very real consequences of making a bad refinancing decision?

Predatory lending really means that a lender influences you to refinance your home in such a way that is not in your best financial interest. Homeowners often become blinded by perceived short-term benefits, losing sight of important long-term goals.

The number one mistake to avoid when refinancing your home is canceling too much equity. You’ve worked hard to build equity in your home, and cash-out refinancing options can sometimes cancel every bit of it, making your home virtually worthless to you until you can build up equity again.

However, equity is what allows you to borrow against your home, so canceling some of your equity by refinancing is not always a bad decision. If you are refinancing to consolidate other debt, for instance, this could be a decision that will strengthen your financial situation for the future.

Cash-out refinancing allows you to take cash out of the loan at closing, and while this can be seen as an investment if the cash to be used for home improvement, it is absolutely detrimental if the homeowner spends the cash on something like a new car or boat. The homeowner has then wiped out equity in a home that will only increase in value, and traded it for something that begins depreciating immediately.

Predatory lenders take advantage of homeowners who have difficulty focusing on their long-term financial goals. If you are considering a cash-out refinancing option, ask yourself if your plans for that cash are going to help you reach your long term goals or not.

Refinancing a fixed rate mortgage (FRM) to an adjustable rate mortgage (ARM) to take advantage of current low interest rates is another decision homeowners are likely to later regret. That low rate may look attractive now, but an adjustable rate mortgage is just that: adjustable. Interest rates could rise higher in the future than the rate on your current FRM. Lower monthly payments may seem like a great way to save money, but in the long-term you could end up paying thousands more on your new loan than you would have paid if you’d stayed in the old one.

However, refinancing from an ARM to an FRM is usually a wise decision, even if the fixed rate is slightly higher than the current rate on the ARM. The idea behind refinancing to an FRM is that you lock yourself into an interest rate that you are comfortable with paying.

Refinancing to the same type of loan as the current mortgage for a lower interest rate is also a decision homeowners probably won’t regret. Just be sure you intend to stay in your home long enough for the savings in interest to cover the cost of refinancing.

One other important safeguard against predatory lending is the Federal Truth in Lending Act, which guarantees borrowers who refinance on their primary residence a three day grace period to back out after closing, so long as they are refinancing with a different lender than the one who holds the current mortgage. This is called the “right of rescission,” and very few borrowers take advantage of it, but knowing you have the right to back out of a bad deal makes refinancing your home a little less stressful.

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