money-tree-10057261Ready to refinance your mortgage?  With interest rates so low over the past several years, it seems to be time to get on the “band wagon” and get a lower rate yourself, right?  Maybe so; maybe not.  Before you take this plunge,  you need to give this move some serious thought and make sure that you refinance only for a good reason.  There are several reasons for a mortgage refinance, and you need to place yourself into one (or more) of these categories and look at the pros and cons, so that, in the end, if you choose to do so, you refinance only for a good reason.

  • A Lower Interest Rate:  This is the most common reason for refinancing.  With a lower interest rate, your monthly payments are also lower, and that is always a good thing.  Plus, over the life of the loan, you will be paying less in total interest.  There are a few “rules” you should follow, however, before taking this step.  First, it only makes sense to refinance if you can get at least a 1.5% decrease in interest rate.  Why? Because there will not be enough of a decrease in monthly payment to make it worthwhile.  Remember, there are fees related to mortgage loans – somewhere between 3-6% – and, unless you have the cash to pay them outright, they will be rolled into your new loan.  It can take several years to make up for those fees.  For example, if the fees on a $100,000 loan are 6%, that’s $6000.  If your payment is lowered by $100 a month, it will take 5 years to break even on those fees.  The other drawback is that if you take a new 30-year mortgage, you have added more years to the end of your mortgage.
  • Shorten the Mortgage Term:  Some people refinance for a shorter-term loan.  If you are pretty comfortable with your current mortgage payment, or could even handle a small increase, you are in good shape for a refinance with a shorter term.  Suppose you have 25 years left on your current mortgage.  If you could get a new mortgage, at a lower rate, and the terms are only 15 years, you will have saved a bucket load of interest payments in the long run!  If you want to refinance only for a good reason, this would certainly be one!
  • Change from an ARM to a Fixed Rate:  If you are currently in an ARM, then you know the risk.  If interest rates rise, so will your payment.  It may may sense to get into a relatively low-rate fixed mortgage now, so that you can breathe a bit easier over the years.  The one drawback to this move is if you are very early into your ARM and you have a pre-payment penalty.  You must consider the closing costs and fees and add to them the pre-payment penalty, and then calculate you total new loan and how many years it will take to break even.  On the other hand, waiting for the pre-payment penalty phase to end may mean a higher interest rate when you do refinance.
  • Tap into Your Equity:  You’ve been in your home for a number of years, and you have built up lots of equity.  Now, you would like to do some major renovations to that home and you don’t want to take out a loan to do them; or you have a child ready for college, and you don’t like the prospects of a long-term student loan debt at a higher interest rate than your new interest rate will be. And, you tell yourself, the interest you pay on a mortgage loan is tax deductible.  It all sounds good, right?  Not so fast.  You need to remember that you have just put your renovations or that college education into a new 30-year payment plan that you could be still paying into your retirement. Lenders will encourage you to do this, because your new loan amount will be much higher, and that is good for them!
  • Debt Consolidation:   Oh, this sounds so good!  You’ve maxed out credit cards; you have a car loan at a higher interest rate than your new mortgage loan will be; you have medical bills that you would love to get “off your plate.”  Are you willing to cut up those credit cards?  How long before you have to buy a new car again?  Remember, those debts you are consolidating are now rolled into a 30-year loan.  Research shows, moreover, that the majority of people who refinance to consolidate credit card debt, continue to use credit at a rate that is fairly consistent with their earlier usage.

The bottom line is this:  Only you know your personal circumstances.  Before you take the step, please be sure that you refinance only for a good reason. Do your homework, make a list of the pros and cons, and proceed with a logical and well-though-out decision.