You hear that you can get a lower interest rate on your loan so you automatically think it’s worth it. Would it surprise you to know that sometimes refinancing isn’t all that it’s cracked up to be?
Sure, you can save money and sometimes it’s a great thing to do. Other times, though, the process can be more of a headache and cost you more money than it’s worth. So how do you know when refinancing is right for you?
Keep reading to find out more.
It Will Cost you too Much
Before you refinance, find out how much it will cost. Then you need to compare that cost to the savings you’ll earn. For example, let’s say you’ll save $50 a month, but the refinance will cost you $5,000. It will take you 100 months before you actually see that $50 savings because of how much the refinance cost you. Is it worth it?
For the person that plans to live in the home for the long-term, maybe. After 8 years, he can start seeing the $50 savings, but even that’s a stretch. You can’t predict what you’ll be doing in 8 years. You don’t know if you’ll want to stay in the home or if you’ll even be able to stay. It’s best if you can recapture the savings within a matter of a few years. If it takes more than 3-4 years to pay off the costs of the refinance, it may not be worth it.
You Want to Pay Your Loan off Faster
Many people assume that to pay their loan off faster that they have to refinance their loan into a shorter term. That’s not the case, though. In fact, if you do so, you only make your loan more expensive, because again you have to pay the closing costs.
If you want to pay your loan off faster, you can just make extra payments towards your loan. Just make sure your lender applies the extra payments towards the principal. You can do this in a variety of ways – it depends on how much extra money you have. You can:
- Pay a set amount extra towards the principal each month (such as $100)
- Pay 1/12th of your mortgage payment in addition to your regular payment (this makes one extra payment each year)
- Make bi-weekly payments (pay half of your payment every two weeks, which equals 13 payments per year)
- Make a lump sum payment towards the principal
There aren’t any rules that you have to follow to pay extra towards your principal, so you do what you can afford.
You Want the Equity
If you know you have equity in your home, you may think it’s a good idea to take it out of your home. Refinancing with a cash-out refinance gives you access to this equity, but should you do it?
The reason you need the money should determine this answer. If it has anything to do with the home itself, it can be a valid reason. For example, do you need a new roof or you want to add a room onto the home? The money you take out of the home will enhance the value of the home, which will provide you with the equity once again quite quickly. If you want the funds to take a vacation, pay off debt, or do anything non-home related, it may not be your best option.
Remember, refinancing costs money, so you are paying to get access to your own money. Wouldn’t it be better to wait until you are ready to sell the home and you can have your funds in hand without paying thousands of dollars to get to it?
Your Credit or Financial Situation Isn’t Good
If your financial situation, including your credit score, has changed since you bought the home, you may get worse terms now than you did then. If you want a lower interest rate, you’ll need great credit, a low debt ratio, and stable employment. If something changed in those areas, you may not be able to get the low rate that you anticipated.
Even if you can refinance, it can be stressful, take a long time, and be expensive. You may be better off keeping the loan you have now and making the best of the situation. If you wanted to refinance to get cash, consider a personal loan or credit card. If you wanted to refinance to lower your interest rate, keep the rate you have and save the money on the closing costs.
Refinancing typically only makes sense when you can recoup the closing costs in a short amount of time. Unless you need the funds to reinvest in your home, then it could be worth it too. Otherwise, you may want to leave well enough alone and not refinance so that you can save the thousands of dollars in closing costs and continue to pay your loan down as scheduled.