Home loan refinancing is not always the best idea, even when interest rates are low and friends and colleagues are talking about who fetched the lowest interest rate. Before you begin the long process of gathering pay stubs and bank statements, think about why you are refinancing. While some financial goals such as easing your monthly cash flow, dealing with a financial emergency, or paying off your home loan sooner, can be met with a refinance, here are seven bad reasons to refinance your mortgage.
When is Refinancing a Bad Idea?
While Consolidating Debt - This can be one of the most dangerous financial moves any homeowner can make. On the surface, paying off high-interest debt with a low-interest mortgage seems like a smart move, but there are some potential problems. First, you are transferring unsecured debt, for example, credit card debt, into debt that is backed by your home. If you are unable to make the loan payments, you can lose that home. While non-payment of credit card debt can have negative consequences, they are usually not as dire as a foreclosure. Second, many consumers find that, once they have repaid their credit card debt, they are tempted to spend again and will begin building up new balances that they will have more trouble repaying.
To Switch to Long-Term Loan - While refinancing into a home loan with a lower interest rate can save you money each month, be sure to look at the overall cost of the loan. If you have 10 years left to pay on your current loan and you stretch out the payments into a 30-year loan, you will pay more in interest overall to borrow the money and be stuck with 20 extra years of loan repayments.
Save Money for a New Home - As a homeowner, you need to make an important calculation to determine how much a refinance will cost and how much you will save each month. If it will take three years to recoup the expenses of a refinance and you plan to move within two years, that means despite the lower monthly payments, you are not saving any money at all.
Switching from Variable to Fixed Rates - For some homeowners, this can be an excellent move, particularly if you intend to stay in the home for years to come. But homeowners who are simply afraid of the bad reputation of variable interest rates should carefully look at their rate terms before making a move to refinance. If you have a variable interest rate loan, make sure you know what index it is tied to, how often your loan adjusts and, even more important, your caps on the loan adjustments: the first cap, the annual cap, and the lifetime cap. It may be that a fixed-rate loan is better for you, but make sure you do the math before committing to spending money on a refinance.
Cash for Investing - Even when the stock market isn't rocky, this is not a generally good idea. The problem with cash is that it is too easy to spend. If you are disciplined and will truly use the extra money to invest—or to build your emergency fund—this can be a good option. However, paying down a home loan can be a better deal than putting your cash into an investment option with lower returns. Make sure you are a savvy investor before playing with the equity in your home.
Reduction in Payments - In general, reducing your monthly payments by lowering your interest rate makes financial sense. But don't ignore the costs of refinancing. In addition to the closing costs and fees, which can cost from 2% to 3% of your home loan, you will be making more EMI payments if you extend your loan terms. If, for example, you have been making payments for seven years on a 30-year home loan and refinance into a new 30-year loan, remember that you will be making seven extra years of loan payments. The refinance may still be worthwhile, but you should roll those costs into your calculations before making a final decision.
Take Advantage of a No-Cost Refinance - A "no-cost" home loan does not exist. There are several ways to pay for closing costs and fees when refinancing, but in every case, the fees are paid one way or another. Homeowners can pay cash from their bank account for a refinance, or they can wrap the costs into their loan and increase the size of their principal. Another option is for the lender to pay the costs by charging a slightly higher interest rate. You can calculate the best way for you to pay the costs by comparing the monthly payments and loan terms for each scenario before choosing the loan that works best for your finances.
Things to Consider While Opting for Home Loan Refinance
A casual or impulsive decision made for home refinance could prove to be costly. Therefore, it has to be carefully evaluated and all the factors must be considered before finalising home refinance. Here are some key factors that may influence your decision:
1. Financial Factors - Refinancing has its own set of costs which include, legal fees, processing fees, incidental charges with the new lender, prepayment charges with the existing lender (if you have taken a fixed rate home loan), etc. Ensure to carry out a thorough cost-benefit analysis before taking the leap. The decision is not just about a lower rate of interest. Refinancing should mean a substantial net saving by the time the loan is repaid in full.
2. Non-Financial Factors - The interest rate is not the only factor that influences refinance. You should also look for intangibles such as brand name, reputation, customer-friendly policies, service aspect, the safety of documents, etc. Repayment terms and conditions specified by the new lender would also play a role in your decision. Another factor you need to consider is the timing of the refinance – at which stage of your loan repayment are you going for refinancing and what is the principal outstanding amount? It may not make much sense to refinance a loan that has been repaid to a large extent (say 70% or more).
What is refinancing?
Refinancing lets you change your home loan to suit your new circumstances.
What do I need to consider when refinancing?
When done properly under the right circumstances, loan refinancing can be very beneficial. However, there are drawbacks involved - namely the cost. The reasons for refinancing should be legitimate and the calculations need to be run to ensure the long-term savings outweigh the short-term costs.
How to refinance my home loan?
You can check out some of the refinancing options online and carefully assess the offers against your requirements.
Home loan refinancing can look tempting to homeowners looking to reduce expenses. But it’s not always a good idea. Depending on your situation, refinancing can either save you money or cause a variety of problems. While the attraction of lower interest rates and smaller monthly payments makes sense at first glance, it’s crucial to understand the potential risks involved.