Mortgage refinancing can be a smart financial decision, but it’s not always the best idea, even if mortgage rates are low and you know that your friends and colleagues have been able to secure lower mortgage rates. This is because refinancing your mortgage can be a very time-consuming process, expensive to close, and will mean that your mortgage lender will pull your credit score.
Before you start on the long process of gathering all of your pay stubs, bank statements, and other paperwork you’ll need to refinance, think carefully about why you want to do this. There are some financial goals, such as easing your monthly cash flow, dealing with a financial emergency, or paying off your mortgage sooner, that can be met with refinancing a mortgage. There are also some bad reasons to refinance your mortgage, so think twice if your reasons are one of these.
To Consolidate Debt
Consolidating your debt can often be a good thing, but if you’re going to do it, you will have to do it right. In fact, if you get debt consolidation wrong, it can end up being one of the most dangerous financial moves that you can make as a homeowner. Paying off high-interest debt with a low-interest mortgage seems like it would be a smart thing to do, but there are lots of potential pitfalls with this route.
The first problem is that you are transferring unsecured debt, such as credit card debt, into debt that has your home backing it as collateral. If you are unable to make your mortgage payments at any point, you could lose your home. If you don’t pay your credit card debt off on time, this can have a negative credit score consequences, these consequences are usually not as dire as a foreclosure and losing your home.
Secondly, many consumers find that once that have paid off their credit card debt, they are very tempted to start spending again, and can start to build up a new balance, that they will then struggle to pay. It can land you in more debt than you started with.
To Move Into A Longer-Term Loan
It can save you some money each month to refinance into a mortgage that has a lower interest, make sure you carefully check the overall cost of the loan. For example, if your current loan has ten years left to pay on it, and you then change these into payments over a new 30-year loan, you will end up paying a lot more in interest overall in order to borrow that money, and be stuck paying mortgage payments for another 20 years.
To Save Money For A New Home
As a homeowner, you will need to make a very important calculation to work out exactly how much a refinance will cost you, and how much you might be able to save every month. If it will take you three years to recoup the cost of a refinance and you want to move to a new home within the next two years, then this will mean that you aren’t actually saving any money at all, even if you have lower monthly payments on your mortgage.
To Switch From An ARM To A Fixed-Rate Loan
For some homeowners, switching from an ARM to a fixed-rate loan can be a smart move, especially if you plan to stay in your current home for years to come. Homeowners who are only afraid of the bad reputation of an adjustable-rate mortgage (ARM) ought to carefully look at their terms before they make a move to refinance their mortgage.
If you have an ARM, then you should make sure that you know the index to which it is tied, how often the loan adjusts, and what the caps are on loan adjustments for the first cap, annual cap, and lifetime cap. A fixed-rate loan could be better for you, but you need to do the math before you make the decisions to spend money on a refinance.
To Take Cash Out For Investing
Even when the stock market is at it’s most stable, this is usually not a very good idea. The problem with cash is that it is far too easy to spend. If you are disciplined with your money and will truly use the extra money from refinancing to invest in a smart way or to build up an emergency fund, then this can be a good option. However, if you will be paying down a mortgage at 4% per year, this can be a better deal than putting your cash into a Certificate of Deposit (CD) that will earn 2% every year. Make sure that if you make this decision that you are a savvy investor who has a clear understanding of both the risks and potential upsides before playing with the equity in your home.
To Reduce Your Monthly Payments
In general, it does make financial sense to reduce your monthly payments by lowering your interest rate. However, you shouldn’t ignore the costs that come with refinancing. As well as the closing costs and fees, which can range from 2% to 3% of your home loan, you will also have to make more mortgage payments if you plan to extend your loan terms.
If, for example, you have been making mortgage payments for seven years on a 30-year mortgage, and decide to refinance into a new 30-year loan, you will need to remember that you will be making seven extra years of loan payments. The choice to refinance could still be worthwhile, but you should make sure you count these costs into your calculations before you make your final decision on what to do with your mortgage.
To Take Advantage Of A No-Cost Refinance
There is no such thing as a ‘no-cost’ mortgage loan, so you must be careful if you ever see an offer that claims to be one. There are a few different ways to pay for closing costs and fees when you refinance a mortgage but in every case, those fees will have to be paid in one way or another, by someone. In other words, you as a homeowner can these costs from your bank account for a refinance, or you can pay those costs wrapped into your loan, which will increase the size of their principal.
Another option for no-cost loans is for the lender to pay the costs by charging a slightly higher interest rate or including closing points. You can work out the best way for you to pay these costs by comparing the monthly payments and loan terms for each possible scenario before you choose the loan that works the best for your finances.
How Does Refinancing Work?
The process of refinancing your mortgage is very similar to the way that you got your mortgage in the first place. In most cases, you would start by shopping around and comparing different interest rates and other terms with various mortgage lenders to see which has the best offer for you. You can then compare that offer with the terms of your existing loan.
If your credit has improved since you were approved for your first loan, you should have a good chance of qualifying for more favourable terms.
As you go through the process, keep an eye on the closing costs. Or example, if you refinancing your loan a new lender will cost you $5000 upfront and gives you a monthly payment that is only $100 lower than what you’re paying now, you will need to stay in your home at least 50 months to make a move worth it.
Watch out for things like prepayment penalties, which could cause problems later on if you pay off the mortgage early or refinance again.
How Often Can You Refinance Your Home?
There are no regulations that place a cap on how often you can refinance your home, but lenders usually do set their own limits. Some lenders will also impose prepayment penalties on existing loans. Whether or not you will be able to refinance will depend on the equity that you have in your home, and how strong your credit score is. If your credit score is lower than the previous time you refinanced, you might not be able to get approval from your lender.
Finally, you must keep in mind that every time you choose to refinance your mortgage, you will have to pay closing costs and fees which could take you years to recoup. Each time you try to refinance, your credit score will be pulled by lenders. This can have a negative impact on your credit score if it is done too often.
The Bottom Line
In the right circumstances, refinancing a mortgage can be a smart financial move for lots of different homeowners, especially if they need more than mortgage relief alone can provide. However, not every refinance makes sense. Be sure to carefully evaluate all of your different options before you make a decision about refinancing your mortgage.