When Is Refinancing Your Mortgage A Bad Idea?

When Is Refinancing Your Mortgage A Bad Idea?

Many people ask themselves whether refinancing their mortgage is a good idea. There is no doubt that this can be a viable option if there is a well thought out strategy behind it, or if a financial emergency has cropped up. However, there are several classic cases in which going for a refinancing home loan is simply not recommended. More often than not, borrowers are motivated by the wrong reasons, and this can end up costing them more.

Understanding how mortgage refinancing works is the key to making wise decisions. Before you ask yourself how to refinance a mortgage, it is best to ask yourself why you are looking for one in the first place.

Securing Lower Interest Rates

Everyone wants lower rates for obvious reasons. However, refinancing your mortgage to get lower rates could end up costing you a lot of money in the long run. This is due to the fact that lower interest rates will cause the loan term to be extended, and this means you are paying more years of interest overall. Also, additional fees may further nullify all the potential benefits associated with lower rates. 

Similarly, refinancing homes with bad credit is not recommended, as, in addition to the effect described above, your credit rating could suffer to a great extent. If you are already in debt, you need to pay special attention to make sure that your financial decisions consider the impacts on your credit score.

Lengthening The Loan Term

Many people make the mistake of opting for refinancing with the sole purpose of spreading out their repayment installments over a longer period. This could mean that you might have to pay a much higher amount overall.

For example, if your existing loan term is for 10 years and you want to extend it to 12 years, you will end up paying more money in the form of interest for those additional years. Although your immediate monthly burden might lighten, you will have to shell out more money in the end. Therefore, lengthening your loan term is not a good enough reason to refinance your mortgage. It is best to go for other measures to ease the monthly payments load.

Reducing Your Monthly Payments

Many people choose to refinance their mortgage in order to reduce monthly payments, based on lower interest rates. This could certainly make financial sense, but be careful not to ignore the cost of refinancing itself. 

According to estimates, the costs of mortgage refinancing in the US can be as high as 3% of the loan amount, not including closing costs and fees. This is an extremely high cost that many borrowers sometimes forget to factor in the overall decision. Instead of using money to pay fees, you could utilize it for paying off your other obligations, thus improving your overall financial situation.

Always remember that even with “zero-cost” loans, fees are paid in one way or another. This is done by either increasing the principal or by being charged a higher interest rate. When it comes to immediate relief in monthly payments, there are no true shortcuts.

Consolidating Debt

Refinancing your mortgage in order to consolidate debt can be an extremely risky strategy. Many people tend to believe that it is a great idea to pay off high-interest debt with a low-interest mortgage, as this seems to make financial sense. However, this idea could prove to be dangerous because of two major reasons:

• Unsecured debt is being transferred to a loan that is backed by your house. If you do not repay the loan on time, then you could even lose your house as a result.
• Even if you pay off your credit card loans by taking out a mortgage, you could be tempted to take another unsecured loan, thereby putting your house at risk again. 

Therefore, refinancing your mortgage in order to consolidate your debt is not a good idea, however tempting it may be. This could only add to your personal financial strain and lead you towards a debt trap. It is extremely important that your refinancing decisions are based on valid reasoning that has a long term strategic vision in mind.

Conclusion

You should not refinance your mortgage with short term goals in mind, such as decreasing your monthly payments or pushing back the end of the loan term. These strategies could cost you more at the very least, or even be extremely risky.  A rule of thumb is to refinance your mortgage only when it is absolutely necessary, so that you can avoid the effects described in this article, as well as fees that might not justify the decision and will cost you more overall.