Should I Refinance My Mortgage?

If you have a mortgage, it’s almost certainly the biggest debt you carry.  That being the case, it makes sense to examine that debt and look for ways to reduce the cost.  Smart Pilgrim.

The thing is, even if you find a lower-cost loan, a refinance is not always a slam dunk.

There are costs associated with this decision – some of which you may not have considered yet.  We’ll go through that together.

First, let’s go over a few very important questions you need answers for before you sign on the dotted line:

Why do you want to refinance your mortgage?

You could be interested in refinancing in order to reduce your cost – but you could have other motivations.

Maybe you want to cash out and pay off credit card debt, or (heaven forbid) use the money to pay for one of your kid’s expensive college education.

Or, maybe you just want to beef up your emergency account because you spent all your money on a wild vacation to Bermuda.

I don’t like these ideas and I’ll tell you why.

I’m a fan of refinancing to save money or use it to make a very smart investment, but it’s not a good idea if  it just helps you spend more.

So if you are just using the dough to send the kids to school, reexamine your process.   And if you want to take some money out of the house so you can live it up with a sweet “vaca” – forget about it completely Joe.

It might be savvy to refi in order to pay off high-cost debt for example, or buy another property. But only if you’ve taken the necessary steps to insure you won’t get right back into debt again and that the property purchase is a sound financial move.

(Tip: buying a second home is cool if you can afford it, but it’s usually not a good financial investment and therefore, rarely makes financial sense if you are borrowing in order to make that happen).

Are you refinancing just so you can spend more?  Be honest with yourself. Capishe?  This is the first and most important step to take.

How much will you save?

If you refinance at a lower rate, you might save big bunches of dollars. However, before you refinance, you need to make sure the savings are greater than the costs that come with refinancing.

There are closing costs and origination fees to consider. Sometimes the costs are so high it feels like the mortgage broker is the only one making out on the deal.

In order to compare the costs to the benefits, you have to make some assumptions about how long you think you’ll own the home.

For example, let’s say you can save $2500 a year in interest costs if you refi, but it will cost you $5,000 to get the loan.

In that case, it takes only 2 years in order for this to pay off.  That might sound OK.  But if there is a good chance you will have to sell the home in 2 or 3 years, it might be a mistake to spend the money.

Bottom line?   If you aren’t planning on being in your home for a significant period of time, your interest savings may not be large enough to overcome the costs associated with refinancing.  Calculate your savings and payback period based on the length of time you will likely stay in your home.

The value proposition of refinancing also depends on how much you owe and/or want to refinance.  A small loan may cost just as much as a large loan in fees but if the balance is small, it may take longer to recoup the savings from the lower interest rate.

If you do carry a low balance, consider alternative ways to refinance  rather than use a traditional lender.

TIP:  If you do refinance in order to save money every month, think about how you are going to spend that loot.  Pay down other loans?  Fine.   Invest?  Great!   Blow it at the track?  Not so much.

Summary

Refinancing can be really smart.  It can actually propel you to the next level financially.

This is especially true if you are taking cash out of the deal (refinancing more than what you owe) and use the proceeds for a very smart investment.

Even if you just free up monthly cash flow, this can be a smart move.   Just make sure that if you doing a cash out, the bread gets invested and used very wisely.

This has to be an INVESTMENT – and not an expense.

That means (in my book) not for education, fun or just spending.   Even if you are buying a business or a property, the investment has to make sense financially.  Check your numbers chicos.

If you refinancing to save monthly cash flow, great.  Make sure the benefits outweigh the costs and be sure to put that savings to good use – like saving and investing.