While it may be hard to believe, there are cases where the best mortgage rates are the worst for your finances. If they tempt you to make decisions that cost money instead of saving, then what seems like a lot can really be devastating.
It can be tempting to refinance your home mortgage when you have the money to make a major purchase. Luxury vehicles, boats, campers, new furniture and expensive cruises or vacations are typical large purchases that homeowners can use as excuses to raise a mortgage when interest rates are low. The problem with this is that these purchases quickly fall in value – your debt increases, but your assets do not. Instead of building prosperity, repeated cash-out refinancing when the mortgage interest rate is low has a negative effect on your overall equity balance.
But even if you do not withdraw money, this does not mean that you cannot go wrong by refinancing. Homeowners refinancing every few years rarely pay off their mortgages within 30 years, extending the amortization period and paying more interest. This puts their family in a precarious position if the loss of a job or illness would result in an inability to make mortgage payments.
Refinancing can indeed be careful and even beneficial for your financial future. Unfortunately there are several times that this is not the case.
Refinancing for the wrong reasons
1. Refinance Cash-Out
“Payout” refers to borrowing money against the equity that has built up in your home since you last negotiated your mortgage.
Refinance cash-out for new purchases
Consider a couple who bought a house five years ago for $ 150,000 with a $ 112,500 mortgage for 30 years at 6%. Today their home is worth $ 160,000, and they owe $ 104,686 in mortgage. The pair learns that they can now refinance at a rate of 4%. They are eligible to add $ 15, 314 to their mortgage, increasing it to $ 120,000. Because the rate is so low – and they really want some new furniture and a flat-screen TV – they decide to go ahead and reduce their debits to 30 years to keep their payments low.
This couple withdraws money or borrows against the equity that they have built up in their home. They are now paying interest on this loan for the next 30 years.
Serial refinancing with extra funds
Three years later, the same couple received both promotions. Due to their regularly planned mortgage payments, the mortgage balance has been reduced to $ 113,398.47. Their home is now worth $ 165,000 and their increased income now qualifies them for a $ 123,750 mortgage.
After considering moving to a larger house, they choose to stay in their current home, believing that they are making an economical choice. They then treat themselves to a European vacation by adding money to their mortgage and again taking the debits back to 30 years to take advantage of the still low rates.
The problem with this scenario is that this pair will probably never pay off their mortgage. Eight years after buying the house, they still have 30 years to make mortgage payments, and instead of using low rates to their advantage, they just get deeper into debt. Their home value does not appreciate as quickly as their debt, and carrying the mortgage requires both incomes. If they have to sell the house quickly, they may not earn enough to pay off the mortgage. If they decide to start a family, they may not be able to afford to keep one parent at home and may have difficulty meeting childcare and mortgage payments. Plus, by raising and repeatedly renewing the loan, although they lower interest rates, they will eventually pay more interest.
2. 30-year term refinancing
Not all homeowners want to pay if they refinance. Some homeowners simply want to borrow money at a lower interest rate to reduce their mortgage interest costs and monthly payments – but by expanding to another 30 years, they may miss significant Portugal interest savings.
A better mortgage interest rate might not be the best deal
If a couple refinances the outstanding balance of $ 104,686 to a 30-year term at 4% five years after their mortgage term, the total interest paid is $ 74,888. However, if they refinance in the 25 years that actually lagged behind the original mortgage, their total interest is only $ 60,736.83. They save $ 14,124 in additional interest by refinancing to a 25-year term over a 30-year period and reducing still their monthly payment.
Refinancing for the right reasons
Refinancing to a lower rate is financially justified, but sometimes getting the best mortgage rates leads people to borrow more money for things they don’t need. It is all too easy to fall into the trap of refinancing, resulting in a larger mortgage, paying more interest generally, and pushing your mortgage-free date far into the future.
Please note the following before signing up on the dotted line to renew or extend your mortgage:
- Why are you refinancing?
- If you add extra money to the mortgage, what is the money used for? Does this have a positive or negative effect on your capital balance?
- What will this do with your long-term financial goals?
- How many years does this contribute to the mortgage?
- Do you have a mortgage with a prepayment penalty? If so, how high is the refinancing fine?
- What are the closing costs for refinancing, including all application and start-up costs, appraisal and legal costs?
- How long does it take to recoup your mortgage refinancing costs? Will you stay at least that long in the house?
- Perform a repayment schedule for your current mortgage and one for a refinanced mortgage. Add the mortgage refinancing costs to the total interest on the latter and compare it with what you have to pay in total for your current loan. Which is more expensive?
Knowing when, why and how you can refinance your home is the key to making a good decision to improve your financial situation.
1. Good reasons for a Cash-Out Refinance
Some situations justify refinancing with additional funds, especially if you reduce your total total financing costs and do not extend your depreciation period to the original 15- or 30-year term. Some homeowners use the money to renovate and increase the value of their property, or to improve their education, get a better job and increase their income. Others use refinancing to ultimately increase their net worth and reduce debilitating credit card payments by consolidating high-interest debts into a lower-interest mortgage. However, this tactic can be dangerous because it secures the unsecured debt through your property, which means that the inability to pay it can result in the loss of your home.
2. Refinancing and the mortgage term
Getting a rate that lowers your monthly payment while it is low enough to offset the costs of refinancing is a common reason for refinancing. Whether your refinancing also involves a payment, it is important to keep the mortgage term at the remaining amount of the original term and to prevent it from being extended to 30 years. The longer the repayment period or the time required to repay the loan, the more interest you pay, and the additional interest payments that result, can destroy and even exceed the money saved through refinancing.
If a refinancing is carried out correctly, this can save families money in the long run, but refinancing often without taking long-term costs into account is a costly mistake. Paying refinancing for consumer purchases, repeatedly returning to a 30-year depreciation and paying hefty mortgage prepayment fines for refinancing are all potentially dangerous habits for homeowners. Instead of jeopardizing your financial future by refinancing your house to pay for expensive toys, you save for such purchases by creating long-term financial goals that provide you with the money you need without borrowing money.
If you suspect that you may need to refinance in the future, avoid mortgages with early repayment penalties that add thousands to the costs of a possible refinancing. And if you can’t find at least one way that refinancing will help you reach your financial goals, don’t do it.