Refinancing A Good or Bad Idea?

Interest rates are low and you may be thinking about refinancing.  If you do, there are a couple of things to consider.

When I bought my first home I was still digging my way out of debt so I ended up getting a FHA loan.  After two years, I refinanced to a conventional mortgage, I did so for two main reasons.  One, I wanted to drop the mortgage insurance that was required with a FHA loan, that saved me around $70 a month.  Second, I had the opportunity to reduce my interest rate by two full points.

If you are going to refinance stay away from adjustable rate mortgages (ARM).  These look very appealing with the offers of 3.5% APR.  Adjustable means just that, the mortgage company has the ability to adjust the rate over the life of the loan.  Remember the typical home mortgage is 30 years.  Sure rates are low now, but who is to say what they will be 15 years into the mortgage.  What if they go up to eight or nine percent? Don’t say it will never happen.  Over the last 30 years or so look what the interest rates were.  Mortgages in 1976 were 8%.  My first home in 1996 had an interest rate of 7.375%.  It’s better to finance to a fixed rate especially since the rates are low now.  That way you won’t have any surprises in your monthly payments over the life of the mortgage.

So if you are going to refinance be sure you:

1. Move to a fixed interest rate
2. Reduce interest rate by at least two points
3. Eliminate mortgage insurance for FHA loans

Know what you are getting into when you consider refinancing.  Don’t forget to take into account closing fees.

When not to refinance

You may be tempted to pull equity out of your home to pay off unsecured debt, credit cards, student loans, medical payments, etc.  Most people do this to reduce their monthly payments.  This is not something I recommend mainly because statistics show that you will most likely be in credit card debt again within two years.  By reducing your monthly payments, and not learning how to properly manage your money you will start spending again and building up more debt because you will “think” you can afford it based on your monthly outgo.

Don’t refinance just to reduce the term of your mortgage.  Even with an option of a lower interest rate you may be able to pay off your home quicker, save closing cost and reduce your total interest paid just be increasing how much you pay on the mortgage each month.  For example, I currently have a 30 year mortgage; however, I am making triple payments each month.  Turning my 30 year mortgage into a three year mortgage.  No refinancing needed, I am saving on interest since I am shortening the term of the mortgage.  Plus since I am not refinancing I am saving on closing costs.

If you do decide to refinance know what you are getting into and read the fine print.  Be in charge; don’t let the mortgage broker talk you into something you don’t fully understand.

Insure you are aware of:

  • Prepayment penalties “ Seems silly I know, but there are some mortgages with terms that will penalize you if you make extra payments and/or pay off the loan early, that would include refinancing. There is no reason why you can’t find a mortgage with no prepayment penalties.
  • Increase in property taxes/homeowners insurance “ Many mortgage companies/brokers may require a home appraisal and some even require a home inspection.  Depending on the findings, this could increase your property taxes and homeowners insurance.
  • The Cost of closing costs “ If you think you will be moving in the next 7 to 10 years you may not recoup those closing costs.  It may actually cost you more money in the long run to refinance.

The home mortgage is the largest single financial decision you will ever make.  Insure you know all the specifics before you sign on the dotted line.