You've probably heard refinancing "horror stories." But when it comes to finances, knowledge is power. Know the ins and outs of mortgages, including how to refinance yours, and this information will be a major asset to you.
Luckily, if you're one of the many who find themselves asking, "is refinancing bad?" we're here to provide some answers.
Here's the truth about refinancing, what it entails, and 7 mistakes to avoid when refinancing your mortgage so you can get the financial help you need while enjoying peace of mind.
What is Refinancing?
Before you consider refinancing, let's talk about what it is. To put things simply, when you refinance your mortgage you are basically getting a new mortgage that replaces your previous one.
Most often, homeowners refinance their mortgage so they can get a lower interest rate and better term on their house.
Customizing Your Mortgage
When you got your first mortgage, your financial needs may have been quite different from what they are today. This often leads homeowners to refinance or create a new mortgage because refinancing allows you to customize the terms of your new mortgage.
Through refinancing you can actually pay your home off more quickly or you can decide on a lower monthly mortgage payment.
When you refinance, you can even choose the type of rate you will pay. Either an adjustable rate or fixed.
You might be tempted to refinance to borrow against the equity of your home and pay off credit card bills or get money for large home improvements. We'll get into whether this is always a good idea or not
Is Refinancing Bad? 7 Mistakes to Avoid
Now that you've got the gist of what refinancing is, let's get down to the nitty-gritty. Here are 7 mistakes to avoid when you're refinancing your mortgage:
1. Refinancing to Pay off Large Debts
This "mistake" may shock some folks who assume that getting a lower interest rate mortgage to pay off a high-interest rate debt is a good idea. But here's why we list it as a potential mistake...
When you refinance your mortgage, you are essentially borrowing money against the value of your home. This means that if you cannot make your mortgage payments, you could end up losing your home.
No one likes the terrible feeling of massive credit card debt, but missing payments on even high-interest rate debts like credit cards still don't result in you foreclosing.
Make sure to change your spending habits if you refinance to pay off debt, otherwise you will be left with a higher mortgage payment and (eventually) the credit cards will be maxed out again.
2. Refinancing to Reduce Monthly Payments
Ok, there is truth to the fact that refinancing can mean having much lower monthly payments.
However, if this is your only reason for refinancing, be aware that there are costs to refinancing that may negate the benefits of having those lower monthly payments.
For example, how long will you keep your new mortgage loan? Are you going to be paying less each month only to be paying your mortgage off for more years?
Just be sure to do the math before using this as your reason for refinancing so you don't end up "robbing Peter to pay Paul."
Know the closing rates, application fees, and title fees of a new mortgage and be sure to add those into your calculations.
3. To Get Cash for Investing
Does it really matter what you are using the cash for if you're getting it through refinancing? The current rate of credit card debt in the United States is a testament to the fact that it is incredibly hard to resist spending money--even when you don't have it.
This is why refinancing your home for cash purposes is such a risk.
There are some definite reasons that make refinancing worth the risk. Events like family emergencies, medical expenses, death, unforeseen major repairs or accidents, and sometimes even children's education expenses may be worth refinancing a home for.
However, refinancing for the sake of spending cash is never recommended.
Some homeowners may justify refinancing by saying they intend to use the cash for investment purposes. Even investing that cash is not always a financially wise or a responsible reason for borrowing against the value of what may be your biggest asset.
Unless you are a wizard in the art of self-control, it's best to avoid the temptation of borrowing against the value of your home for investing. Unless the investment you choose is earning a great deal more interest than the rate of your mortgage, you're taking a risk by refinancing.
4. To Get a Longer-Term Loan
We touched on this idea already. Still, we think it's worth listing as its own mortgage"mistake" to avoid. Refinancing to get a longer-term loan is not likely to save you money. On the contrary
Are you currently locked into a mortgage with about 10 or 15 years left and thinking of refinancing to get a 30-year mortgage?
The interest you will earn on those additional 15-20 years of payments will end up being a lot more money out of your pocket than if you'd stuck with the shorter term.
Not only will this longer mortgage-term cost you more, but it will rob you of the freedom of being debt-free for much longer. Again, math is key to determining whether refinancing will end up being worth it to you.
Some lenders offer a flexible term to help you offset a longer term. For example- you have 27 years left on your 30yr loan, want to refinance into a lower rate/payment but do not want to lose your place in the amortization schedule. Flexible Term allows you to accomplish both goals, in this example. Not all lenders off this so make sure to inquire if you would like to know more.
5. To Get Cash for a New Home
Again, the idea that refinancing your home to get money for purchasing a new home is potentially faulty.
Keep in mind those important costs to refinancing. Depending on when you are planning to sell and move, the costs to refinance may be hard to recover.
The refinance may not be worth it if you move sooner than those lower monthly mortgage payments can allow you to save up enough to regain the lose and afford a down payment on your next home.
6. Refinancing to Opt for a Fixed-Rate Loan
If you are simply concerned over the effects of having an adjustable-rate mortgage, (ARM), you should consider carefully before refinancing.
What index is your adjustable-rate mortgage tied to? Do you know how often your loan adjusts or what the caps are on those adjustments? These are questions to know the answers to before deciding if it's really worth it for you to move to a fixed-rate loan.
For some individuals, a fixed-rate loan is a very wise move. This is typically the case if you are going to be living in this same home for more than 3 years.
However, once you know the answers to such questions, you should crunch the numbers to determine if spending money to refinance is worth getting a fixed-rate loan in the long-run.
7. Refinancing to Scoop a "Deal"
We're sorry to break it to you but there is no such thing as a "no-cost" mortgage. Deals may come and go, don't be pressured into refinancing simply to take advantage of what some may call a "no-cost refinance."
It's a fairytale.
You may find multiple ways to pay the refinancing fees (closing costs, application fees, etc.). But be aware, they will be paid. The when may vary, but there's no question about the "will."
You may consider paying cash for these costs or adding them into your loan. This, however, will increase the amount of your principal.
Your lender might offer to pay them, but be aware this means you're likely going to get a slightly higher interest rate. If your rate is high enough and you are going to be out of the home in under 5 years, it may make sense to use the lender credit to pay all closing costs so nothing is added to your loan balance, even though your payment could have been slightly less. In the long run, if you are not going to hold onto your house for an extended period of time, try to add as little as possible to the mortgage balance during a refinance.
Just like we said, there's no real way out of paying those refinancing costs, so don't be pressured into refinancing simply to grab a "deal" if you haven't really hammered out the math and found it to be a financially wise move.
Is Refinancing Right for Me?
According to CoreLogic, about half of homeowners in the U.S.A. today have a mortgage rate that's under 4%. Things are looking good for homeowners with their primary mortgage rates in this arena. Of course in places like Seattle where mortgages are through the roof, things may be different and refinancing may be worth considering.
At the end of the day, no two homeowners have the same financial profile or situation. Determining if refinancing is right for you is a matter of math.
You can read and understand all the pros and cons of refinancing but to make the right decision for your own wallet will never be cut and dry.
Find Help Making a Choice about Refinancing
Now that you've got the answer to the age-old question, “is refinancing bad?” it's time to whip out the calculator and decide for yourself.
While making this choice on your own may be intimidating, you don't have to go it alone. You can get help with making the right decision by speaking with experienced mortgage brokers who can assist you in assessing your situation and the pros and cons of refinancing.
There may be some downsides to refinancing when done for the wrong reasons, but if you're wise it can be a financially lucrative move.