Record low interest rates create another refinancing boom. Banks and brokers profit big, but what about you and me? Just because you lower your interest rate does not mean that you are saving money. Refinancing could look good and still hurt you. There are times when refinancing can save you thousands of dollars and bring you closer to your goals, but is it always a good idea? Here are five reasons why refinancing could be a bad idea.
1. Extended breakeven periods: When I look at a refinance, I start with breakeven. This is the point where your monthly savings recoup the cost of making the loan. To calculate this, take the cost of the refinance, which will include all of your lender’s fees, appraisal fees, and closing costs, and divide it by the monthly savings. This will give you the number of months you will need to have the loan in order to recoup the costs.
I will recently refinance a couple of properties with a breakeven point of almost four years. It’s usually a lot longer than I’d like to see, but I never plan to sell these houses, so I have a high level of confidence that I will still own them after four years. I didn’t think I would have the opportunity to set the rates that I did, so I did. Knowing that my break-even point is about four years, I know that after that everything is savings for me.
2. Closing costs can be high: I was surprised by the costs of making the loan with my last refinance. These were smaller loans, so with fixed costs like appraisals and closing fees, the total costs to close as a proportion of the loan amount were high. Of course, you can most likely pass the costs onto the loan, but even that comes at a cost. Rolling your closing costs onto a loan means you’ll pay interest on those fees for the next 30 years.
Be sure to review your lender’s cost estimate and question the fees. Do this before committing to the loan and before ordering the appraisal. Often times, there are also ways to lower your interest rate by increasing your closing costs. These are called “reduced purchases”. Review your purchase options with your lender and see what the breakeven point is for each option. Often times, you need to stick with a slightly higher rate to keep closing costs low.
3. You’ll end up paying more interest: Repayment schedules are an amazing thing to keep payments consistent over the life of the loan, but they create a devastating disadvantage. Have you ever looked at your mortgage statement to see how much of your payment is applied to principal? Repayment schedules, while necessary, hurt borrowers in the early years of the loan. Most of your payment is applied to interest and very little goes to pay off the loan. As you progress through the repayment schedule, you will find that more and more of your payment is applied to pay off the loan. In most cases, with a 30-year loan, you must wait more than 15 years before even half of your payment is applied to the principal. A major downside to consider when refinancing is that you will restart your repayment schedule and start over, which means that most of your payment will be applied to interest again.
4. Extended Pay Periods – This is true for a few reasons. First of all, as we’ve discussed, you will most likely extend your repayment schedule, which means that you will pay more interest each month, but that also means that you will make loan payments over a longer period of time. Every time you refinance, you may be pushing yourself harder and harder to pay off your loan.
5. Debt Consolidation Won’t Save You Money Automatically: Debt consolidation can have huge positive impacts on borrowers. Especially with monthly payments and a debt settlement plan. But it can also hurt you.
Credit card debt is extremely difficult to pay off because the minimum payment requirements are structured to extend the time it takes to pay off the debt. It also allows you to borrow again after reducing debt. Sometimes moving these debts into a refinance is the only way to move forward, but be careful. By doing this, you are spreading the debt for 30 years and will have the ability to use your cards again, which would put you in a much worse situation.
The subject of debt consolidation is complicated. Often times, it is best to seek help from a professional. Even when the loan appears to be of benefit to you, it may not benefit you, or if it appears to harm you, it may be helping you. I remember a deal I worked on when I was a mortgage broker where we consolidated credit card debt and my client’s monthly payment went up. That wasn’t a great scenario for him in the short term, but it provided a huge benefit in the long run. In this example, we made a loan with no prepayment penalty or costs. No-cost loans are possible with higher interest rates. We eliminated all of her credit card debt, which was significant, and that increased her score by over 100 points! With the new higher credit score, he qualified for much better loans, so we waited about six months and refinanced him again, saving him over a thousand dollars a month. Your short-term payment increase with the consolidation loan could have saved you from eventual bankruptcy. I just hope you stop using your credit cards.
Making the right financial decision: There are many different reasons why you might be considering a refinance. Refinancing a home or rental property can have huge benefits. It allows you some flexibility to speed up your payment schedule, it can lower monthly payments, or it can free up some much-needed cash. There are different types of lenders that can help you with a refinance, including traditional lenders and banks, but if you need to free up cash to complete a construction project, you may need to consider hard money. Hard money lenders can be expensive, but they can provide you with the cash you need when you need it. They also get you to the closing table quickly. When done right, a hard money refinance will get you to the finish line.
It is important to see the disadvantages of refinancing a property in order to make the best financial decision. Understanding rates, terms, and repayment schedules is important in analyzing the deal and making the final decision. This can be a difficult decision to make, so don’t go it alone. Contact a lender you trust to investigate your situation and see if a refinance is right for you. Find who we recommend on our pine recommendations page.
