Should I Refinance My Mortgage?

Rates are still very low and if you’ve got a mortgage, it’s smart to think about refinancing.  But as low as rates still are, it’s not always smart to go through the pain of a refi.  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?

Before making any major money decision, it is a good idea to consider your motivation. Why do you want to refinance? Do you think it will save you money each month?  Are you thinking about buying a 15 year term and paying off the 30 in order to get paid off quicker?  That might be a good move.

Perhaps you want to cash out in order to get money for a vacation or to pay for your child’s college. Maybe you want to qualify for a mortgage on a second home and need the cash for a down payment.  I don’t like these ideas and I’ll tell you why.

I’m a fan of refinancing to save money but it’s not a good idea if all it helps you do is spend more. So 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 buying a second home is cool if you can afford it, but it’s usually not a good financial investment.  Are you refinancing just so you can spend more?  Be honest with yourself. Capishe?

How much will you save?

If you refinance at a lower rate, you can save thousands of dollars. However, before you refinance, you need to make sure the savings will overcome the costs that often come with refinancing. There are closing costs and origination fees to consider. Sometimes the costs are so high it feels like a complete real estate scam rather than a good financial move.

In some cases, 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. It also depends on your outstanding balance.  The lower the balance, the less it makes  sense to refinance because some of the more expensive fees are fixed regardless of the amount you plan to take.  So borrowing cheaper money to pay off high-cost loans isn’t always the way to go.

Another reason some folks refinance is to improve their monthly cash flow.  This can be a good move in some cases.  If you refinance to a lower rate – or the same rate but over more years – you will increase your monthly cash flow. That’s true.  Just remember to consider the trade-offs and don’t get suckered in  by those juicy savings.  Do the math.  Compare the cost of the refinance to the savings you’ll enjoy and figure out how long it will take to pay off the cost of the refi.  If it takes longer than 24 months, I’d pass.

Is a cash-out refinance a good idea?

A cash-out refinance can be tempting. This is because you may want to use the money for something else. When you cash out, you use the equity in your home — the ownership you have built up — for some other purpose like a vacation or for your childrens’ education.

Even though the interest rate may be low (and tax-deductible), consider the costs of your actions. Is there some other way you could save up? Are there other options to finance a college education (like sending the kids to a less expensive school)?

Consider that when you engage in a cash-out refinance, you are reducing the ownership that you have in your home. If you run into trouble, you could lose the home. Is that risk worth it?  It also sets up a very dangerous precedent.  Once you open that cookie jar, you may find it difficult to stay away.  And if you dip into your equity too often, you’ll eat it all up.  That can cause a very nasty case of indigestion Pilgrim.

This Simple Trick Will Tell You If Refinancing Is Really Your Solution

Sit down and do the numbers.  If you can pay for the refinance within 2 years, that’s a good sign (and one I would insist on).  But even if the refi pays for itself, ask yourself what you are going to do with the money that you free it up.  Are you going to save and invest that money?  If so, this sounds like you have a winner on your hands.

If you are just going to spend the money, your work isn’t done.  Yes, you still might want to refi, but that isn’t going to change your life.  If that money is going towards your lifestyle or paying off debts, this is a huge red flag.  And if that is the case, the thing that WILL change your life is if you take a hard look at your spending plan.

Ultimately, what you decide to do with your money is up to you. Refinancing is a major step, and you should consider the consequences of your decision. Some people think that if the numbers work you should you should go for it regardless.  If refinancing will help you meet long-term goals of saving money and building wealth, or if it will help you with more immediate cash flow issues, it might not be a bad plan. But before you use a cash-out refinance, it’s a good idea to examine what the real challenges are and address those issues as well. If not, you may find that your refi is just helping you dig a deeper hole.

Are you refinancing now?  Why or why not?