Refinancing your mortgage may not always be a good idea, even if interest rates are low. Before you start the process of collecting all your paperwork and financial documents, really think about the reasons for the refinance. Some financial goals, such as reducing your monthly payment or paying off your loan sooner, may be a good idea with a refinance, there are many situations where a mortgage refinance is a bad idea, such as those outlined below.
#1 Consolidating Debt
This can be a very dangerous move by a homeowner. On the surface of it, paying off your high interest credit cards with a low interest rate mortgage may seem wise, but there are some serious red flags. (Investopedia.com)
First, remember you are transferring your unsecured debt into debt that is secured by your house. This is a very dangerous proposition. If you cannot make the new loan payments, you will lose your house. Not paying your credit cards carries consequences, but it does not mean foreclosure on your home.
Second, many people find once they have paid off their credit cards, they just run them up again. Now they have more credit card debt, plus the higher payment on the home.
#2 Save Money to Buy a New Home
You need to figure out how much the refinance will cost and how much you will be saving each month. If it takes 36 months to recoup the expenses of your refinance and you are going to move next year, this means even with the lower payments, you are not really saving money.
#3 Take a Longer Term Loan
Refinancing into a new loan with a lower rate can save you every month, but look at what the loan is costing you. If you have 10 years to pay on the loan and you stretch it out into a 30 year note, you will pay more in interest over time to borrow that money and be paying 20 more years of mortgage payments. See 15 year vs 30 year mortgage differences.
#4 To Go From an ARM to a Fixed Rate Mortgage
This can be a good move if you plan to stay in the home for many years. But homeowners who are simply afraid of having an adjustable rate mortgage should look at the terms of the ARM before they decide to refinance. If you do have an ARM, know the index the interest rate is based on, how often it adjusts and what the cap on the loan is. It may be that the fixed rate loan is the best option for you, but you should run the numbers before you decide to refinance.
#5 To Pull Out Cash for Investments
The problem with taking out a lot of cash is it is very easy to spend it. If you are very disciplined and will use the extra cash for smart investing, it may be a good choice. There are some good real estate investment options out there that can make you 10% or more on your money, but you really need to know what you are doing to make sure you do not end up losing money. See cash out refinance rules.
#6 Reduce Monthly Payments
Reducing your payment each month makes sense in some ways. But never ignore the costs of doing the refinance. In addition to closing costs and fees, which run 2% to 5% of the loan, you also will be making more payments if you extend the loan term. If you have been making payments for seven years on your 30 year mortgage and refinance into a new 30 year loan, you will now be making seven more years of loan payments.
#7 To Do a No Cost Refinance
Always remember there is no such thing as a no cost refinance. There are a number of ways to pay for closing costs and fees when you refinance, but you will be paying them one way or another. You can pay cash from your bank account for the refinance, or you can wrap the costs into your new loan and increase the loan amount. Or, the lender can pay the costs and charge you a higher rate. You should run the numbers to decide the best way to pay for your closing costs. Just remember: You will always pay for the closing costs in the end.
Sometimes doing a mortgage refinance is a smart financial move, but if you are doing it for any of the above reasons, be cautious.
- 7 Bad Reasons to Refinance Mortgage. (n.d.). Retrieved from https://www.investopedia.com/mortgage/refinance/7-bad-reasons-to-refinance-mortgage/