Every time interest rates drop a quarter of a point you hear a commercial on the radio that you should refinance. When the economy is on fire and home prices are increasing, you hear ads about taking equity out of your house. Every time you hear these ads, they get you to ask yourself, “Should I refinance?” How do you know if you should or not? When is a good time to refinance?
Should I Refinance
If you are refinancing because you heard some guy on the radio, then that’s a bad reason. If you are looking at refinancing because it will be a while before you pay off your mortgage, then it might be okay for you. There are some good reasons to refinance, but there are many reasons why you should not refinance.
When to Refinance
One good reason to refinance is if you can save money in the long run. If you are not on baby step 6 and won’t get there for a while and you have a high interest rate, then you can consider refinancing. In this situation you have to do the math. You need to calculate how much interest you’re going to save over the term of your loan. You also need to consider closing costs and other fees associated with refinancing. If the numbers work out, then refinance.
If you have an adjustable-rate mortgage and will not be paying it off before the rate adjusts, then you should consider refinancing to a fixed-rate mortgage. If you have an FHA or VA loan and are paying mortgage insurance, then once you have 20% equity in your house and qualify for a conventional loan with no PMI, you should consider refinancing.
Don’t Refinance to Consolidate Debt
As a general rule, don’t refinance to consolidate debt. Don’t take unsecured debt and put your house as collateral for it. If you get into a situation where you no longer can pay that debt, you can lose your house now that it is collateral. Hopefully, you are doing well with your finances, but sometimes you get into situations where you can no longer make payments. This could be because of a disability or job loss or medical reasons. Even if you have your financial life in order, these things can still happen.
Now, there may be a few situations where refinancing to consolidate some debt is okay. If your debt snowball is going to take a while and you already have liens on your house because of some debts, then refinancing and consolidating those debts into your mortgage might make sense. Most of these cases are when your debt is not bankruptable. This would include federal student loans and any debt owed to the government like tax debt. I am not saying run out there and refinance all these debts and consolidate them with a new mortgage. In most cases this is not needed. Get on a budget. Earn additional income. Pay off your debts as soon as possible.
Don’t Refinance to Take Equity Out
If you are following a plan to eliminate your debt, then you have already established that debt is not good and that you have no need for debt. You are trying to eliminate your debt and not add to it.
Don’t think of your house as a piggy bank. What’s the point of paying off your mortgage only to borrow money against it? When you take equity out of the house don’t think this is free money. You need to pay that money back. It’s a debt that you now have. You might have well just rented since you have no equity now.
I can think of one situation where it might make sense to take equity out of your house and that is if you need to stave off bankruptcy after you have done everything else with your finances. If you are going to declare bankruptcy, you might as well take equity out of your house to pay off your debts. Even in this case, you only do this if it helps the situation in the long run. It’s probably better to just sell your house and rent or buy one that you can afford.
Don’t Refinance if the Math Doesn’t Work
When you are considering refinancing because you won’t be paying off your home anytime soon, you need to do the math. Find a calculator online to make this easy for you.
In order to know if the math works out, you need to consider the difference in interest rates and the other fees associated with refinancing. You need to decrease your interest rate by 1-2% in most cases in order to make it worth it.
Don’t Refinance to Lengthen the Term
If you are going to refinance, you should always consider shortening your term. Your mortgage should be around 25% of your monthly budget with a 15-year fixed-rate mortgage. If you are refinancing and are going to break these guidelines, then consider not doing it. You will most likely hurt your monthly budget and your financial life. If you are not going to shorten your term by refinancing, then you need to consider selling your home and buying one that you can afford. Don’t be afraid to rent.
You do not need to refinance to shorten the term, either. If you are paying off your mortgage early, then it doesn’t matter the length of your term. You apply all available money to your mortgage.
Don’t Refinance if You are Going to Move
Don’t refinance if you know you are going to move in the next few years. You need to consider this when you do the math. You might get a better interest rate refinancing, but you will not recoup the closing costs in just a few years. Do the math as stated above.
There are many reasons to not refinance, and there are very few where you should. Don’t refinance just because you heard an ad on the radio, and don’t refinance if the math doesn’t work out. The best way to handle your mortgage is to get out of debt, save an emergency fund, and pay off your home mortgage early.