Refinancing can be very advantageous to the right borrower. In fact, today’s low interest rates have got thousands of Americans considering a possibility they would’ve never thought of three years ago, especially after the devastating housing crisis of 2008.
There are various reasons to refinance. You might want to take advantage of today’s climate and get a lower interest rate. That way, you can save on the payments you pour out every month. Another reason is to combine both the first mortgage and purchase money second mortgage into one loan. This is more commonly called “purchase money consolidation refinance”. Or you want to tap into the equity you’ve earned on your property and want to take it out as cash.
Yet, like any other financial decisions, taking a refinance should entail some careful considerations on your part. Most mortgages take more than a decade to pay off and that is too long a time to spend in a costly mistake.
As you may have read some pretty convincing and sensible reasons why you should take on refinancing on a separate post, here we lay some weighty counter-arguments as to why you maybe shouldn’t. These are not meant to discourage you from venturing into refinancing but instead aimed to give you perspective so you can make a wiser financial decision in the future.
A Question of Cost
Refinancing is not free. Think of it as paying for the same product twice. You will need to put in money for origination, lender fees, and other charges that are wrapped into the closing cost. The bigger the loan you take out, the larger the amount you need to pay to refinance.
Your lender may suggest that you wrap the closing cost on the loan. But they will also compensate it by giving you a higher interest rate. The best way to get over this dilemma and make sure you will not be paying more on your refinance is to calculate the break-even point. This number will tell you the length of time it will take for you the recoup the cost of the refinance. If you plan to move in five years, for example, and the break-even point goes beyond that period, it means you will lose money on the refinance.
Longer Pay-Off Time
So you’ve been running into the eighth year of paying your first mortgage and now you plan to refinance. If you refinance to the same loan term, that means you will add another 8 years of mortgage payments. If you do not make a large initial principal payment, you will spend more years paying before you fully own the property. Pay attention to loan structure when you refinance so will have an idea what portion of the amortization term is dedicated more to paying for the principal and for the interest.
Being underwater on your mortgage means owing more than the current market value of your home. There are many reasons why mortgages become underwater. One of this is through refinancing. Some take out cash on their built equity and when the market gets unstable and home prices go down, the unexpected happens and their mortgages go underwater.
To avoid this scenario however, some borrowers put down significant down payments on the refinance as a buffer.
Another risk is switching from a fixed-rate mortgage to an adjustable one. Market crashes are not unheard of and they can happen anytime. The borrower who is courageous – or perhaps knowledgeable – enough to take this shift risks the possibility of rate hikes at the time his or her mortgage rate is adjusted.
But this is also overriding the possibility of the exact opposite happening, as what has transpired just a few months ago with the Brexitcontroversy.
Nevertheless, a contingency plan should be set and one must understand this risk before he or she takes the step.
Refinancing can offer a world of advantages when done for the right reasons at the right time. But it could also mean a ton of headaches and regrets when taken incautiously. Make sure you know the pros and cons well before you forward your application.