3 Hidden Dangers of Refinancing Your Mortgage
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Donald Kilgore One of the few pleasant developments from the recent market turmoil is sustained low mortgage rates. With rates at historic lows, many homeowners are able to refinance their mortgages, shaving hundreds off their monthly expenses. But refinancing isn't always a good choice even if it lowers your monthly payment, because there can be hidden traps. Here are a few such dangers to consider before you decide to refinance. (See also: 6 Great Reasons for Paying Off the Mortgage on Your Home)
Refinancing can stretch out your loan terms.
When you refinance, you are essentially getting a completely new loan. If you are 3 years into your 30-year fixed rate loan, for example, you have 27 years of payments left. Even if you refinance to a new 30-year loan, you've essentially stretched out your payments for another 3 years. In some situations, stretching your loan further into the future may be exactly what you are looking for, but just make sure you indeed want to increase the length of your loan before committing to the new terms, as opposed to merely wanting to recast your mortgage.
There are fees when you refinance.
This may not show up in your documents, but every borrower pays a fee to obtain a new loan. Don't listen to any of the mortgage myths that are out there that claim otherwise. After all, the money used to pay the loan officer has to come from somewhere. Sometimes the fees are wrapped into the entire loan, so you end up with a bigger loan amount. Other times, you are paying for it using a higher loan rate. Whatever the case, there is a cost with the new mortgage. When you work out the specifics of whether refinancing your home loan makes sense, make sure you are considering all fees involved.
It's easy to take money out when you refinance.
Perhaps the most dangerous trap of all is the fact that you can easily take out built-up equity every time you refinance. Homeowners need to recognize that money borrowed is money that needs to be paid back eventually. And as we saw in the financial crisis, falling home prices can put a huge stress on homeowners who are maxed out on their mortgages. Even if house prices go up forever, if you serially refinance, there comes a point in time when you have to sell your home to pay off your mortgage just to keep up with the monthly mortgage payments.
The surest way to lose your house is to continually refinance with a higher loan amount than what you currently owe. The true meaning of home ownership is to reduce your mortgage debt until you own it free and clear. If you don't want to keep your home, then keep taking money out by refinancing.
Refinancing your mortgage could be the closest thing to getting free money, especially when the current rate is lower than the rate on your loan. But think carefully before you hastily apply for another loan application, or else your home could be in jeopardy.
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Regarding your point about fees.
If you are able to remortgage and include all the fees in the new loan and the rate is lower than you currently have - you absolutely should remortgage. Yes the new rate is higher than it would be for a loan with fees and points. However, since the new rate is lower anyways - what does it matter that you could have gotten lower - if getting the lower rate means paying fees that you do not want to pay.
I got a 15 year 5.25% loan in 2008, a 10 year 4% loan in 2010 and 3.5% 10 year loan in 2011. All 3 loans came with no points and no closing cost paid by me - yes as I mentioned above I realize my rate is highter. However, I was able to remortage 1 year after I last did, pay nothing out of pocket and decrease my rate by .5%.
I might even have another few chances to remortgage again!!!!
Hi David, sounds like you kept yourself on the same payoff schedule as well. All the refinances you did were absolute no brainers and probably will end up saving you a significant amount of interest over the life of the loan.
Point number one in the article is a good one. Going with a new loan at a lower rate doesn't necessarily save you money in the long run if you're stretching back out over a longer loan term. It's important to analyze the amount of interest left to pay on the current loan versus the total interest bill on a new loan.
There have been scenarios I've worked on where the borrower is getting a significantly lower interest rate, cutting down their loan term, and still not saving any money over the life of the loan because they've already paid so much of their current loan off and the payments are mostly principal at this point. When evaluating whether a refinance makes sense, you have to look beyond rates and fees. Those are important, but it's important to analyze how the interest is accruing in your current loan and on the new loan.
It is so important to emphasize the scope of the decision to refinance; the situation for the homeowner really has to be just right for refinancing to be the right decision. It is NOT a quick fix and something to decide on in a hurry. If homeowners keep this in mind along with the risks you so clearly outlined here, I think a lot of people will be able to avoid the risk of losing their homes. Yet again, solid advice everyone should follow!
You missed the most important point.
When you refinance a mortgage you restart the amortization. People are often shocked at how amortization works. The first payment is virtually 100% interest and very, very little principal. Gradually over the life of the loan the proportion of principal in the payment rises until the final payment, which is nearly 100% principle.
If you sell or refinance, you restart the mortgage back at payment #1. It is pure stupidity to do this unless you get a SIGNIFICANTLY reduced interest amount.
This is why double payments are so valuable. The additional amount paid goes 100% toward principal thereby lowering future interest.
good point, but...
if someone wanted to refinance to lower their monthly liability in case of possible future unemployment they should.
as long as you do not get a loan with prepayment penalties (which i can not fathom why anyone would get such a loan) one could pay all the money they save each month towards principal. It is likely that this extra principal would be more than they were paying before (obviously one should look into such numbers). this would leave them with less mortgage payment each month if something happens to their income, increasing the time savings could last.
i would love to do this but can't because our home isnt worth what we owe. i am hoping this new plan that obama mentioned the other day actually happens.
Here is another pitfall - some institution, let's say AME Financial Corporation, bets in the bond market and loses, so says they cannot honor your loan commitment even though you already paid for the appraisal that AME commissioned, that actually came in high. You tell them you will sue them if they don't honor the commitment, and so they hire LandSafe to make another lowball appraisal that is $100,000 less, claiming you now have no equity in the home, so the loan to value is too low, and though they really want to, AME Financial Corporation no longer has to make you the loan, and you are out your time, appraisal fees and now even worse, have a low ball appraisal on the books that Schwab will later refer to that keeps them from making you a home equity loan for the same reason, even though they were the ones that made the refinance loan after AME did not based on yet another high appraisal.