Refinancing your mortgage may be an excellent strategy to save a lot of money on your mortgage in the long run. If not used wisely, however, a refi could make your home much more expensive to pay off.
On paper, mortgage refinancing may seem like a great idea. With any refi, you are essentially taking out a second mortgage when rates are lower and using the funds to immediately pay off your first mortgage. You should only consider a refi if interest rates have dropped at least 2 percentage points from the rate you're currently paying on your mortgage. Your goal with any refi should be to have a lower interest rate, which will lower your overall debt.
Timing is everything if you want to maximize the potential savings of a refi. If you plan to move out of your home in less than 5 years, the refi fees will cost you more money than the monthly payments on your first mortgage. On the flip side, if your mortgage is almost paid off, refinancing will cost you significantly more as you’ll now be extending your remaining debt into yet another long-term loan. Refinancing is more advantageous for mortgages that aren’t expected to be paid off in a short period of time.
An alternative to a refi is to make larger payments on your mortgage if there are no penalties for paying off the loan early. This will help you pay off the mortgage sooner and avoid the potentially costly fees associated with a refi.
You need to be aware of all the potential costs and other fees associated with a mortgage refi before you sign the dotted line. For starters, you may be responsible for paying application fees upfront. Not all lenders will charge you fees to apply for a refi, however.
When you are preparing to finalize the deal on a refi you should demand full disclosure of all fees, terms and conditions of the refinance. Get everything in writing. As a consumer, that is your right and your responsibility. The more questions you ask, the more informed you will be and the better decisions you will make.
When you close the deal on a refi, you will have to pay closing costs once again. Some lenders may also include “points” in your refi. Each point you may be charged will be a percentage of the total loan amount that will be added to your loan. If you are charged points you will need to figure out if you can pay off the points in enough time to save some money. If you have enough money you may be able to pay points off when you close the deal, which will lower your monthly refi rate.
If you paid fewer or no points with your previous mortgage, any points you may be responsible for paying on a refi may eliminate potential cost savings. If your refi has a conversion clause your refi could become even more expensive.
In addition to the potential costs involved, a refi should only be used to pay off a prior mortgage. Short-term debts such as credit cards or even automobile payments should never be paid off with funds from a refi. The interest you’ll pay on a long-term debt isn’t worth taking care of a few smaller debts.
You should also avoid using a refi to pay for home improvements that don’t add much value to your home. You’ll spend much more in interest than you’ll earn in equity in your home.
If used properly, a refi could save you tens of thousands of dollars over the life of your mortgage. If you’ve refinanced your mortgage more than once you can deduct the points from previous refis from your taxes and save even more money.
If you’ve taken out an adjustable rate mortgage (ARM) you may also save a lot of money over the course of your loan if you opt for a fixed-rate loan when interest rates are low. Otherwise you’ll be at the mercy of yearly fluctuations in interest rates that may leave you paying higher interest than you can afford.
Don’t forget, the goal with any refi should always be to ultimately spend less money on your mortgage. Shop around and compare the various rates and fees. The decisions you make will ultimately impact your financial well being far into the future.
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John Campbell is the writer and editor of CashBuzz, A financial portal for the rest of us. Check out cashbuzz.com for the latest articles on money management and tips and tricks that can help improve your finances. This article may be reprinted on your Web site if the copyright, author information, and active link are included.
