Wednesday, March 1, 2017

Don't Be An Idiot Refinancing Your Home

Refinancing your home seems like a no-brainer when interest rates are lower than your current adjustable or fixed rate loan.  Or is it?  Most people, when asked to comment on the benefits of refinancing their mortgage, will tell you that it allowed them to take cash out (from their equity) and pay down other debt or do a major home improvement.  They justify getting a new mortgage on their home by explaining that they were able to lower their monthly payment on account of refinancing into a lower interest rate.

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There are times when refinancing your home makes financial sense.  If your home has appraised enough, e.g., you owe $250K and the appraised value of your home is $375K with interest rates lower than your current fixed rate, getting a new mortgage at $375K and getting over $100K in cash out for the purpose of buying rental properties, I say go for it!  I would not use that money to remodel my home because no project will ever get you a dollar for dollar value.  You'll be using $100K to maybe add $85K in value to your home.  Rental properties allow you to get assets that'll pay you monthly income (if you buy right) and your return on that $100K will be worth much more over time.

Another great reason to refinance is your mortgage converting to an adjustable or variable rate in the immediate future.  Rates are rising so you can pretty much guarantee an increasing monthly payment.  In this case, by all means, refinance!  Paying off high interest credit cards or other debt with the cash you take out from your home is also a smart move, but you shouldn't have gone there in the first place.  What a waste.  

Now let's look at how idiotic it can be to refinance your home.  As you may already know, most of your payment when just starting out on your mortgage goes to interest.  Very little of your payment actually goes to paying the principal.  You can look at an amortization schedule of your loan and see for yourself.  So when you refinance like to like, meaning if you had a 30-year fixed rate loan and you refinance into another one, even with a lower interest rate, you've essentially reset the clock.  Continuously refinancing puts you right back in the interest-paying portion of your new loan.  Let's also not forget that refinancing costs money up front!

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If you plan on living in your current home for most of your life, why would you want to return to the interest-paying portion of a new loan?  But mortgage interest is deductible, you may be thinking.  Did you read my last post on how there's very little tax savings in mortgage interest on your home?  You should read it so you can realize how badly the bank is going to screw you collecting all that interest when you make the minimum monthly payment on a 30-year fixed rate loan.

So what should you do when considering refinancing?  Refinance to a 15-year loan instead of a 30-year one.  Your monthly payment will be higher with a 15-year loan, but at least you'll pay a whole lot less interest over time.  Yet another obvious solution is to make larger mortgage payments if you've already refinanced back into a new 30-year fixed rate loan.  Making 13 payments a year works wonders to reduce your interest costs.

Okay, so don't think refinancing to a lower rate on your mortgage is penalty free.  You'll owe more on your home AND be back at the mostly interest-paying portion (first 15 years) of your amortization schedule.  Not good.  Refinance into a 15-year loan to avoid being an idiot.  Thanks for reading!  If you found this post to be informative and want to get more like them, please consider subscribing below.  Also hit some likes on some of my social media buttons on this page.   
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