CAUTIONS IN REFINANCING YOUR MORTGAGE
It’s Not Always a Good Idea to Refinance
It may seem that refinancing your mortgage to a lower interest rate is always a good idea. The news is blaring with opportunities to refinance. One would think, if a lower interest rate means you pay less money on your mortgage, then that must be good. However, there is more to the story. A mortgage is only one part of a person’s entire financial picture, a large part, but still only one part. If you think it’s time to refinance your mortgage, here are some factors to consider.
Interest Rate Change
The common wisdom about refinancing mortgages says that it’s a good time to refinance if you can drop your interest rate by at least two percentage points. It’s true that the larger a drop in the interest rate, the more you will potentially lower your monthly payment. It gets a little harder to decide what’s best for smaller decreases in interest rates.
Remember that there are additional up-front costs to refinancing, because you are effectively taking out a whole new mortgage. Depending on how much you will save per month, it could take many months to recoup the closing costs of the refinance. If there is not much of a change in mortgage rates, it may not be worth it.
Fixed or Variable
Think long and hard before you refinance from a fixed to variable rate mortgage. Unless you are certain you will be moving before the payment resets, taking a variable rate mortgage today guarantees you’ll have larger payments in the future, as interest rates rise. With today’s historically low interest rates, you’re usually better off locking in the low rates with a fixed rather than variable rate mortgage.
Refinancing your mortgage may likely affect your short-term financial situation, lowering your cash on hand and available savings. If you are sure that you will be able to ride out any temporary bumps and rebuild your savings, then this is not necessarily a problem. However, if you are not certain about your job security or other aspects of your financial picture, it may be better to hold off on taking advantage of low refinance mortgage rates. If your employment is insecure and you may need short-term savings to see you through a gap in employment, don’t sink those savings into the closing costs of a refinanced mortgage. Even with lower payments, you may not be able to make your bills if you don’t have any income.
Length of Home Ownership
If you intend to move out of your house in a short time frame, then it is probably not a good idea to refinance. Remember the closing costs associated with a new mortgage. If you are not going to live in the house for at least several years, you will probably not save enough in your monthly payments to recoup those costs. You’ll actually pay more for the house than you would if you stuck with your original mortgage.
Consider future events that will affect your financial picture in a big way, such as retirement or sending children to college. The length of your mortgage should fit in with those other plans, so that you don’t end up paying mortgage payments on top of tuition or trying to cover your payments with a reduced retirement income. If you are considering refinancing, look closely at these types of future expectations and plan your mortgage refinance accordingly. Look at your whole financial picture and see where a new mortgage may help or harm you.
We refinanced our mortgage loan in March, 2012 and shortened the term from 30 to 15 years. The payments went up a bit, but the mortgage will be paid off in half the time. If you have a short term left on your loan, be wary of increasing the length of your mortgage.
Who’s refinanced recently? What were the pros and cons for your situation?
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