Imagine this scenario – you have taken a 30-year home loan with a fixed interest rate of 9%. That probably sounded like a good deal, when you initially availed your loan. But, right now, the interest rates have dropped significantly and range around 7.5%. You're able to repay your home loan EMIs, but shifting your mortgage to a lower interest rate can help you save some cash. So, you’re interested in refinancing to enjoy the savings and reduce your loan burden.
While it’s true that refinancing helps in reducing the interest rate, there are several other factors to consider before signing on the dotted line. Here, in this guide, we take a look at the top reasons why you should never refinance your mortgage.
8 Scenarios when you should never refinance
#1: To consolidate all your existing debts into a single debt
It’s one of the dangerous reasons to refinance your home loan. On the outset, closing all your high-interest loans with a low-interest loan may seem like a smart move, but there are some potential problems to be wary of.
First, you are consolidating all your unsecured loans like personal loans, credit card loans into your home loan. This way, if you’re unable to make your refinanced home loan payments in the future, you stand the chance of losing your home. While non-payment of credit card debt has its consequences, it’s not as high as losing your home.
Second, once you transfer all your existing loans to a lower-rate home loan, you are likely to feel tempted to spend again using your credit card. This, in turn, further increases your overall loan burden.
#2: To increase the tenure of your home loan
Refinancing a home loan to a lower-rate loan can help you save some money, by reducing the overall interests you pay. However, very often, while refinancing borrowers make the mistake of extending the loan tenure, thereby offsetting the benefits of the interest saved.
Let's say you currently have ten years left to pay on your home loan. When you refinance it for 30 years, you not only pay more interest, but you're also stuck with 20 more years of EMIs to pay.
#3: When you have a poor credit score
Your credit score plays a crucial role in determining the interest rate you’re eligible for while applying for a refinance. The higher your credit score, the better the deal you can avail. If your credit score is not that good, you are not likely to qualify for refinancing. And, even if you do, the interest rate may not that be great, meaning you don't enjoy much savings on refinancing.
If this is the case, we recommend waiting for some time until you can boost your credit score. This way, you can enjoy better rates and bigger savings.
#4: The loan closing costs are high
Refinancing can indeed help you reduce the interest costs. Still, it's not a smart move, especially when you have to pay high loan closing penalties to your current lender. If your home loan comes with foreclosure costs, then it can eat away any savings that you'd get from refinancing.
So, it’s essential to calculate the cost of refinancing before you sign on the dotted line. Consider the cost of loan closing and compare it with the savings you’d get by refinancing to decide if it’s worth it.
#5: When you stand to lose your long-term benefits
Refinancing doesn’t guarantee that you will enjoy savings on interest. In some cases, refinancing may work against your long-term benefits. This is especially true for home loans that you have been repaying for quite a few years.
Generally, the major portion of home loan EMIs goes towards the interest for the first few years. In such cases, you would have paid more for the interest than the principal. When you refinance a home loan that you have been paying for quite some time, you're effectively going to repay the interest once again, even if it's at a lower interest rate.
Similarly, keep in mind that refinancing a home loan of 20 to 30 years can help you extend the tenure. But, it increases the overall repayment as well. Conversely, you can reduce the loan tenure by refinancing. In such cases, the monthly EMI increases as well. So, you need to guarantee whether you will be able to pay this increased EMI, even if your financial situation changes in the future.
#6: To change from a floating-rate home loan to a fixed-rate home loan
With home mortgage rates likely to fall in 2020 due to the Corona pandemic, it’s not advisable to shift from a floating-rate to a fixed-rate home loan, right now. Even if you believe that locking in the interest rates is the right thing for you to do, make sure to do the math before you commit to it.
#7: Using cash-out refinancing to splurge on luxuries or for investing
The problem with cash-out refinancing is that it gives you surplus cash in your hand, which is too easy to spend. If you use the extra cash to settle bigger debts or to build an emergency fund, then cash-out refinancing can be a good choice. However, if you’re using it to splurge on luxuries or speculate on investments, then using your home to withdraw cash is not a good idea.
#8: When a lender offers “no-cost” refinancing
In general, when you refinance, you stand to benefit from low-interest rates. However, that doesn't mean refinancing comes with "no costs" involved. Besides foreclosure costs, refinancing involves other costs like loan processing fees charged by the new lender. Lenders allow you to pay these costs upfront or fold them into the loan costs.
The fees vary from one lender to another. So, make sure to evaluate all the costs involved and see whether you stand to gain any savings, once you have finished paying all the charges.
Additional Reading: How Best Can You Repay Your Home Loan Sooner?
When done for the right reasons, refinancing can help you save money by reducing the long-term interest on your loans. But, refinancing without considering all the consequences can end up being an expensive mistake. So, make sure that you do not jeopardize your financial plans by refinancing without considering all the implications.
If you suspect that you might go in for refinancing in the future, then make sure that you opt for a loan that comes without any prepayment penalties. Before you refinance an existing loan, make sure to consider all the consequences and proceed only for the right reasons.
Furthermore, don’t forget to crunch the numbers before you finalize the refinancing offer. If the savings are not as much as you expected, then it means that refinancing may not be the best idea for your situation.