Refinancing a home can be a great way to reduce monthly payments and reduce overall debt, if you do it right. But there are times when refinancing will actually leave a negative mark on your finances. It’s important to pay attention to those factors that can turn a refinance loan from a good financial move to a bad financial move.
Assuming the Refinance Loan has More Value than it Does
Too often when a homeowner refinance they assume that financially the refinance will have a greater impact than it actually will. Refinancing your home usually requires a certain amount of equity, especially if you intend to cash out the refinance. The equity is typically determined by a home appraisal, which does cost the homeowner money out of pocket and up front. A typical mistake many homeowners make is to determine the value of their home through their tax assessment before they get it appraised. Tax assessments are not in line with a typical home appraisal. In fact, they are often much higher. So if you see good numbers on that assessment you may assume that you have thousands of dollars more in equity than you actually do. Overestimating the value of the home is not the best move because too often homeowners get the refinance process started only to realize that they are underwater in the mortgage and will not be able to complete it using the standard refinance options.
Another common mistake made by homeowners is to refinance too often. Yes, that refinance is tempting because it can reduce the monthly payment and you may be able to cash out the equity and use it elsewhere, or you want to lock in a lower interest rate. The problem with frequent refinancing, however, is that you never get out from under the loan and you incur closing costs and refinancing fees every time you adjust the loan. Unless you’ve already recouped the money you spent on the last refinance, it may not be the wisest choice to go for another refinance.
Common Pitfalls of the Loan Terms
While assuming the refinance loan has more value than it actually does is a common mistake, there are other mistakes made when it comes to the loan terms. Most of the time refinances are done to reduce the interest rate which theoretically would reduce the overall payment amount of the loan. The idea is if you drop the rate by a half a percent, by the time you’ve paid off the loan you will have paid thousands less in interest. In many cases this is the exact result that the homeowner gets. However, there are a few factors that can make this a bad financial move. First, if you’ve owned the home for many years and are looking at a refinance, you need to consult an amortization calculator to see if you will actually save money. When you first acquire a loan you pay more in interest, but as the years go by you slowly start to pay more and more in the principal. After twenty years, you’re paying quite a bit in principal. A refinance will create a new loan and you’ll be back to square one, paying more interest every month. Second, there are other fees involved such as closing costs and points so you may reduce the interest rate but those fees often counteract that and the homeowner doesn’t save a dime.
Frequently homeowners refinance and secure another 30-year-fixed mortgage. This can reduce the mortgage payments but increase what you’ll pay over the life of the loan. For some homeowners, securing a shorter term mortgage is a better financial move because it will enable them to save money by paying off the loan faster. Don’t overlook the opportunity you have with a shorter-term loan.
There are many benefits to getting a refinance loan which makes it something that you definitely want to consider. However, the key to a successful refinance is to look at all the details and determine what the overall costs will be, including the cost of time and interest paid out over this time. If you find, after you’ve crunched all of the numbers, that the new loan will reduce your payments and the amount paid over time, you may want to contact a loan officer and get the process started. A home loan is an investment. When treated as such it can offer great advantages to a homeowner.
Heres a good site to learn about requiring a good refinance rate when you do a refinance loan.