When Home Mortgage Refinancing Is Not a Good Idea
Home mortgage refinancing can sound quite attractive to homeowners, but it is not always a good idea. Depending on the circumstances, it can either save you money or get you into trouble. While the lure of lower interest rates and monthly payments may look good, it is important to understand the risks.
With this review, learn how home mortgage refinancing can land you in hot water or be a welcome change that gives you a financial boost.
However, if you need a refresher on how home mortgage refinancing works before weighing the pros and cons, get the facts by reviewing "Mortgage Refinancing Basics." Generally speaking, you should avoid refinancing your mortgage if you’ll waste money and increase risk. It’s easy to fall into the traps below, so make sure you steer clear of these common mistakes.
Extending a Loan’s Term
When you refinance, you often extend the amount of time you’ll repay your loan. For example, if you get a new 30-year loan, payments are calculated to last for the next 30 years. If your old loan only had 10 or 20 years left to go, home mortgage refinancing will result in higher lifetime interest payments.
When you get a new loan, most of your payments go towards interest in the early years, and you’ll start from scratch. Plug the numbers into a "loan amortization calculator" to see how your total interest costs will change. While you're at it, learn how amortization works, if you need a crash course.
Home mortgage refinancing costs money. You’ll pay fees to your new lender to compensate them for offering the loan. You may also pay for legal documents and filings, credit checks, appraisals and so forth.
Even if a loan is advertised as a "no closing cost" loan, you will still pay those fees. Generally, this happens through a higher interest rate. To better understand no closing cost refinance loans, research the basics of such loans to avoid common pitfalls.
You can use home mortgage refinancing as a strategy to consolidate debts. Sometimes this helps because you reduce interest rates on your debt, and you may be able to turn consumer debts into tax-deductible home equity debts. But this can backfire if you simply shift the debt and rebuild your consumer debts again.
It can also backfire, if you are unable to get tax benefits from home mortgage refinancing or if you are unable to pay the larger loan balance and risk losing your home. If you’re having trouble paying consumer debts, think twice before putting your home on the line. Consider enrolling in a debt consolidation program before taking such a drastic step.
In some states, home loans have special protection from creditors. In the event of foreclosure, they may not be able to sue you if they lose money on the deal. However, home mortgage refinancing changes the nature of your loan: It’s no longer the original loan you used to purchase your home, so you may lose some protection. As a result of this possibility, you'll need to familiarize yourself with how recourse loans work.