10 Mar The Dangers of Refinancing and How to Avoid Them
A home mortgage refinance can be a way out of a sticky financial situation — but it’s not necessarily a good idea in all cases. Depending on your financial situation, it may not be worth it to refinance, even if you’re able to obtain a lower interest rate or smaller monthly payments. That’s because a refinance is a trade-off, and there are certain refinancing risks to be aware of before you move forward.
While you may be unfamiliar with the dangers of refinancing, you’ll have to deal with the outcome, which could set you back years, financially speaking. That’s not to say that refinancing is always a bad deal or that it’ll hurt your credit, but it is a good idea to have a plan in place whenever you’re considering such a big financial decision since there could be outsized effects that could come back to haunt you.
Dangers of Refinancing #1: Look Out for That Loan Term
One of the most significant dangers of refinancing your home is whether it will extend the repayment period of your loan. Most refinances do, and that means that if you have just 10 years left on your mortgage, you could end up with a refinance that pushes your term out as part of a brand new, 30-year mortgage. In that case, you’d have an extra 20 years of payments over what was remaining on your previous mortgage, which would also push up the lifetime interest costs that you paid over the totality of your mortgage.
The reason this happens is that in the beginning of any loan term, the majority of what you’re paying actually goes to interest, not the principal. After a few years, you’ve paid down much of the interest and the bulk of your money can then start to work on the loan amount itself. If you’re not careful, a refinance could bring you back to the starting point again, where most of your payments are dealing with interest, giving you a long way to go before you’re back to where you started.
To see how refinancing can set you back, just plug the terms of your loan into a loan amortization calculator to see how interest costs change over time.
Dangers of Refinancing #2: Watch Those Closing Costs
Another unintended consequence of refinancing is that refinancing costs money. You won’t be able to refinance your home without covering those costs, even if the costs come out of an additional loan that you’re taking out. After all, a refinance is essentially a new loan, and you’ll have to pay a lender for the convenience of taking out a new loan and reducing your monthly payment. Other potential fees include charges for legal documents and miscellaneous filings, in addition to appraisals, credit checks and other financial requirements.
Of particular importance are refinance loans that are billed as so called “no cost” loans where it’s suggested that you won’t pay any costs, at least not directly. Instead, you’ll likely have a higher loan rate to help cover associated costs, which can add up to a pretty penny over the lifetime of your loan. In general, you’ll want to avoid these no-cost loans since you’re paying the cost elsewhere and may likely pay more over the life of your loan than if you just covered the relevant costs in the first place.
Dangers of Refinancing #3: Debt Consolidation Can Come Back To Bite You
By using the equity you’ve built up in your home, you can actually consolidate debts that you may be struggling to pay off in addition to your mortgage and other monthly bills. That’ll leave you with a larger loan, but it’s the money you take out in a cash-out refinance that can be used to pay off other debts, such as an auto loan or credit cards that you’re unable to keep up with.
For many borrowers, debt consolidation is appealing because instead of four or five different creditors, you could bring that amount down to one with an easy payment that you won’t forget about or put off every month. The low interest rate can also mean that you’ll be paying less in total over the lifetime of the loan, but you have to ensure that you’re not opening yourself up to one of the dangers of refinancing.
That’s because moving debt around isn’t the same as actually paying it off. You may have successfully paid off one loan or a piece of debt, but you’ve really just moved the debt into your home. If you’re already having trouble making payments, that could backfire if you start missing your mortgage payments. That can put everything you’ve worked for at risk since you’re putting your home on the line.
Avoid the Dangers of Refinancing With EnTrust Funding
The experts at EnTrust Funding are well versed in the dangers of refinancing. They’ll help you make the right decision when it comes to your family home, whether you’re looking to take cash out, lower your monthly payment, shorten your mortgage term, consolidate debt or eliminate PMI. Contact us today to get started.