So there are definitely some reasons where refinancing a mortgage could be a good move. Rates too high? Terms no good? Not going to be moving for a while? It could make a lot of sense, and save you money.
But there are equally a lot of ill-advised reasons to look into mortgage refinancing. If any of these are in your sights, step away slowly.
Moving from a fixed rate to a variable rate
A good reason that people refinance is to move to a fixed rate mortgage, one that will never change for the life of the loan.
But you can go the other way too.
Let’s play a game. I’ll give you two options: a 5% fixed rate mortgage, or a 3% ARM.
If you took the ARM, you’d be a victim of short term thinking.
Remember, look at how low mortgage rates at today. Are they going to go up, down, or stay stable over the long term? And which one is the riskiest?
Even if it’s more likely that rates will stay the same or go lower, the risk of an increased rate outweighs the potential savings.
What if, in a few years, your ARM is now 8%? Or 10%?
I’d pick dependability over risk any day. Remember, this is your home we’re talking about. Don’t mess around.
Moving to a longer term
Your monthly mortgage payment is likely the most expensive bill you have. Who wouldn’t want to lower it?
Short of interest rate changes, one surefire way to lower your payment is to refinance with a longer term.
Say you have 15 years left on a mortgage, with $250,000 to pay at 4%. That’s a monthly payment of $1,849.
If you were to refinance to a 30 year fixed at the same interest rate, you’d only pay $1,194, putting $655 in your pocket every month. Who wouldn’t want an extra $655 each month?
The problem is, again, short term thinking. Because even though you save money now, over the long term, assuming minimum payments, you’d be paying an extra $96,814 over the life of the loan. That’s a lot of $655 payments.
Now, if you’re having trouble paying your mortgage, that’s a different story. But if so, you may wish to seek help in places other than just a refinance.
Consolidating other loans
You’ve got a car payment. You’ve got a mortgage. Why not roll them into a single payment?
Because it’s a terrible idea, that’s why.
Let’s say for some reason that you have a 8% car payment rate. (This same analysis goes for student loans or any other debt that one can consolidate.) The terms are usually 3-6 years. If you roll the car into the mortgage, true, you might now be paying a 4% rate, but now your terms have ballooned to 15-30 years!
- A $10,000 loan at 8% paid off in 5 years: $12,166 total
- A $10,000 loan at 4% paid off in 15 years: $13,314 total (9% more)
- A $10,000 loan at 4% paid off in 30 years: $17,187 total (41% more)
And besides, do you really think you’ll get 15 years out of that car? (Certainly not 30.) And if not, do you want to be paying for a car you no longer have?
Getting cash out of the home
You have the ability to roll in other loans because of what is known as a “cash-out”. Simply put, if you’ve built equity in your home, you can refinance and take out more than you need, giving you money to pay off other loans. The extra is added to the mortgage amount.
So given that $10,000 car payment, you could refinance for a value $10,000 higher than you needed, and then use that $10,000 to pay off the car. So you now owe $10,000 more, but at the mortgage rate.
With this in mind, some might see the house as an ATM. You can refinance, and get money out of the home! Free money!
You know what that sounds like, don’t you? I’ll give you a hint:
Ask yourself this: would you borrow money at a rate equal to your mortgage?
If you would, I’m not sure I can help you.
“But what about paying off my 15% interest rate credit cards?”
No. I want you to get that credit card bill every month. I want you to see it. I don’t want to disguise it inside your home, making you think that it’s “good debt” or something. You borrowed that money, and now you need to pay it back. Chasing interest rates will not help you.
Don’t avoid the work
A refinance might make sense for some people, but I have suspicion that some might see the refinance as a way to paper over the real work that they need to do, which is getting their finances in order, paying what they owe, and doing it as quickly and as efficiently as possible.
Do you have a plan, or are you just moving your obligations around? Which one do you think will get you farther? I have an idea.
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