Why refinancing can be a bad idea!

With interest rates at their lowest in history (or at least in a really long time), a lot of people are contemplating the idea of refinancing. First, let me say that I am all for refinancing when it makes sense. As a matter of fact, we recently closed on our own refinance; however, there are several times when refinancing is not a good idea. Before we step through the reasons why you shouldn’t refinance, let’s take a look at some of the benefits/reasons why people refinance.

1. Lower your monthly payment
2. Decrease the amount of interest paid over the life of the loan
3. To eliminate debt

In and of themselves these are all fine reasons to refinance. However, there are some traps that you have to be aware of before deciding to refinance.

Dangers of Refinance

• Lowering your monthly payment – There are two ways to lower your monthly payment during a refinance. First, by lowering your APR, you are paying less interest each month, therefore your payment is lower…nothing wrong with that. Second, if you refinance into a loan that adds years to the term of your loan, your monthly payment will be lower, but over the length of the loan, you may end up paying more interest than expected. Make sure you aren’t hurting yourself long-term for a short-term gain.
• Decrease the amount of interest paid over the life of the loan – This is what we just did. There doesn’t seem to be anything wrong with this refinance option, however, if you aren’t careful, you will end up paying a lot more in closing costs to get the lowest rates. If you can’t afford to pay the closing costs out of pocket as part of the refinance, you will have to roll the closing costs into the loan. The danger here is you are paying interest on the closing costs over the life of the loan. That is additional interest that you may not have thought about.
• To eliminate debt – In today’s economy, more people are trying to pay off debt. If you have equity in your home, you may be tempted to take the cash out of the equity and pay off your credit cards. Depending on the interest rates this may be a very good idea. The danger of doing this, is that unless you have your spending under control, you will very likely begin charging to your credit cards again. If you do pay off your credit card, we recommend you call the credit card company and cancel the account.

Be aware of the unexpected

The most important thing to remember when going into a refinance is that the decisions you make will definitely impact you. Don’t let the mortgage broker talk you into something you don’t understand. A few of the things you need to look out for are:

1. Prepayment penalties – If there are prepayment penalties as part of your refinance, you will pay a penalty if you ever decide to refinance in the future. With the number of mortgage brokers available, you should be able to find one that does not attach prepayment penalties to the loan.
2. Increase in property taxes/homeowners insurance – In order to qualify for a refinance you may find that the appraisal triggers a reassessment of your home. If so, the increased value of your home may result in higher property taxes and a higher insurance premium.
3. Recouping closing costs – If it you are pretty sure you are going to be moving in the next couple of years, it may be costing your more to refinance that you will recoup with the lower monthly payment.

The home mortgage is the largest single financial decision a lot of people will ever make. Don’t let a broker talk you into a loan that is not good for you. Home ownership is part of the American dream, but a few bad decisions in the refinance process will turn the dream into a nightmare.