For most homeowners a mortgage that is signed on as a long term loan will inevitably be cut short with a refinance. When the refinance is completed the first mortgage will be paid in full and the homeowner will have a new mortgage – the one acquired during the refinance. This can happen multiple times during the span of time that a person owns their home. There are a lot of reasons for this – some people want to reduce the monthly payment, others want to take advantage of lower refinance interest rates, and still others are trying to get the equity out so they can sink it into other investments. Regardless of the reason, the fact remains that refinancing is common and almost expected with a home loan. While refinancing can have many benefits for the homeowner, there are a few important details that need to be considered before the refinance takes place.
Your Home Mortgage is a Liability
A house is a financial investment, but it can only be an investment when the loan is being paid down and equity is building. When you first secure a loan you will have an amortization schedule. This schedule shows how much money will be going to interest every month and how much will be going to the actual principal balance. Check out this schedule and you will find that for the first seven years at least, most of your monthly payment is going to interest. A small chunk is going to the principal but you won’t make much of a dent in this until the interest is reduced.
Many homeowners start to get the refinance bug when they see the refinance interest rates drop in the real estate market. They heed the call of lower rates, assuming it means they’ll pay less over the life of the loan, but this isn’t always the case. When you refinance that amortization schedule starts all over again because you are getting an entirely new loan. Compare both schedules and you may find that you pay more with the second loan even though the interest rate is lower. So a lower rate can be enticing but it’s not always beneficial. If you refinance and refinance, you essentially never touch the home mortgage, you extend the life of the loan, and your investment becomes a very big liability.
Fees that Come with Refinance Interest Rates
When you refinance a home you are taking out a new loan and replacing your first loan. So the process for approval on a refinance is much the same as the process for a first time loan. This means that you will be faced with many of the same fees. Some of these fees include appraisal fees, attorney fees, inspection fees, PMI and/or FHA fees, title search, closing costs, etc. In addition to these fees, you may also wind up paying points as well, which typically calculate to around 1% of the loan per point. Multiple points means more money paid out up front.
What all of this boils down to is that the fees that come with a refinance are often so hefty they counteract the potential benefits of securing lower refinance interest rates. These fees, including closing costs, can and usually do amount to thousands of dollars. Sometimes the homeowners pays these up front and out of pocket, other times the closing costs are rolled into the loan. This, of course, increases the size of the mortgage rather than reducing any debt.
For homeowners considering a refinance the fees need to be seriously looked at before jumping in to a new loan. Oftentimes when comparing the amortization of the new loan with the additional fees and the potential equity lost by the restarting of the amortization, homeowners find that the refinance just isn’t worth it. In the long run they end up paying more than they would have if they had just stuck with the original loan.
It’s important to note that these are some of the potential pitfalls of a refinance, and they don’t mean that refinancing doesn’t carry benefits. It absolutely does. It’s just important to do your homework and get all of the information necessary from the loan officers and lenders who will be helping you with your refinance. Ask plenty of questions, do the calculations for yourself, and make sure you know exactly what the financial benefits or risks will be before you sign on the loan.