Low Refi Rates Are Great, But Not for Everyone

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Talk about pressure! Everyone and his brother is clenching a mortgage refinance application in his fist and rushing to a lender. With record-low interest rates, you'd be nuts to sit this one out, right?

Actually, wrong.

While no one disputes that mortgage rates really can't get much lower, there are certain homeowners who actually are better off sitting tight with their higher rates. If any of the scenarios below apply to you, refinancing -- even into a lower rate -- could be a bad financial move. Here's why.

1. You've had your loan a long time.

Mortgages work like this: In the beginning of the loan, what you are paying is mostly interest. But once you've had the loan a while, you begin to actually pay down the principal. If you've had your loan a really long time, you have reduced the amount you borrowed (your debt) substantially -- a good thing by everyone's scorecard. But if you take out a new loan, you are rewinding the interest clock and starting over and won't be paying down the principal anymore -- just the interest.

Refinancing rarely makes sense for a homeowner who has been paying for 20 years on a 30-year mortgage. Refinancing and signing up for another 30 years may lower his monthly bills, but he'll be making payments for 30 more years instead of just 10.

If you are just a few years away from retirement and like the idea of not having a mortgage to pay each month, resetting the interest clock may not be in your best interests. If you need some cash out of your house to pay for college or a new car, a home equity line of credit (HELOC) may be a better bet than refinancing and taking cash out.

2. You plan to sell soon.

Refinancing a loan costs money -- anywhere from $2,000 to $5,000 in closing costs, appraisals, fees and points. If your new loan saves you $250 a month but it takes you seven years to recoup those expenses and you are planning on selling next year, it isn't worth the trouble. To find out whether it's worth it, do the math: Divide your monthly savings into the total cost of the loan and that's how many months it will take to recoup your closing costs (divide by 12 if you want to know how many years). If you are planning on moving before that, don't bother.

And don't be fooled into thinking your loan is "free" because the lender has so graciously rolled the closing costs into the amount being borrowed. All you are doing there is increasing your loan amount and taken yourself that much further away from paying it off. You pay now or you pay later, but you are paying it just the same. And in the meantime, you are paying interest on that extra amount you just borrowed.

3. You don't have a real and present need for lower payments.

Sure, it sounds great to knock a few hundred dollars off your monthly mortgage, but what will you be using the money for? If you don't have a need and are comfortable paying your current loan, why not consider increasing what you pay and knocking down your principal debt faster? "Mortgage repayment is a risk-less investment that yields a return equal to the interest rate on the repaid loan," notes The Mortgage Professor Jack Guttentag on his website.

Here's another way to think of it: You have a 6 percent loan. By paying down what you owe, you are saving that 6 percent interest you would have paid. How many investments are paying you 6 percent these days? If you don't need the money -- and we aren't suggesting draining your rainy day fund here -- and have some extra cash lying around, why not use it to pay off your mortgage faster?

But Guttentag makes a much more valid point: "The bigger story is that the people who most need to refinance are the ones who can't." Lending standards have tightened to the point where those without a job and/or who are struggling to stay in their homes aren't able to get loans.

Also see:
Refinancing Do's and Don'ts
Cash-Out Refinancing: Sign of the Times?
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