With interest rates trending downward over the last several months, refinancing is all the rage. For lots of homeowners, refinancing an existing mortgage to a home loan with an interest rate that’s at least a full point lower than their current rate can hack hundreds of dollars off their monthly payment. This can easily add up to tens of thousands of dollars in saved interest paid over the life of the loan.
But, refinancing isn’t always a good idea. Here are six bad reasons to refinance a home loan.
1. To extend the term of the loan
Refinancing to a mortgage with a lower interest rate can save you money each month, but be sure to look at the overall cost of the loan. Homeowners who are more than halfway through their 30-year mortgage loan probably won’t benefit from a refinance. Stretching out the remaining payments over a new 30-year loan will mean paying more in overall interest, even when it’s at a lower interest rate. Also, by paying a monthly mortgage for many more years than originally planned, homeowners will be tying up their funds instead of having more cash available for other purposes.
2. To consolidate debt
Refinancing a home loan for consolidating debt can be an irresponsible move with devastating consequences.
Mortgages are “secured” debt, backed by the borrower’s home. Credit card debt, though, is “unsecured.” Nothing’s backing it except your promise to pay it back. Because of this, the interest payments on credit cards are generally a lot higher than interest rates on mortgages. This can make it seem like moving debt from a credit card issuer to a home lender is a great idea; but, transferring unsecured debt to a loan that’s backed by a home means the borrower could end up losing their house if they don’t pay the debt.
Refinancing a mortgage to consolidate debt can also be a way of enabling bad financial habits that got the borrower into debt in the first place.
3. To save money for a new home
A refinance will cost money, generally 2-4% of the entire loan. It can take several years just to break even on a refinance. If the borrower is planning to move before then, the refinance won’t save them any money.
4. To splurge on an expensive purchase
A cash-out refinance replaces an existing mortgage with a new loan that is more than what is owed on the house. The difference goes to the homeowner. Some homeowners opt for a cash-out refinance to get their hands on cash for an expensive purchase.
Using a house like an ATM isn’t a recommended practice for several reasons.
First, the loan isn’t cheap. Closing costs can be thousands of dollars. And, if the new loan is more than 80% of the home’s value, the homeowner will also need to pay private mortgage insurance (PMI) until they have 20% equity in the home.
Second, using a home’s equity for an expensive purchase means the borrower will see little or no return on their money. Financial experts, like certified mortgage planning specialist Elizabeth Rose, caution against using home equity for anything that won’t improve the owner’s finances.
“There has to be some sort of net tangible benefit to the homeowner to refinance,” Rose says. “I don’t recommend cash-out refinancing for anything that won’t add security to or improve your financial picture.”
5. To take cash out for investing
Refinancing a mortgage with plans to use the extra cash each month for investing is, generally, not a responsible choice. Cash is easily spent and it takes tremendous discipline to actually invest the money that is saved from a refinance. Also, paying off a mortgage toward a house can actually be a better long-term investment than pouring money into a risky stock.
6. To take advantage of a no-cost refinance
There’s no such thing as a no-cost refinance. A lender might offer to refinance a mortgage with no closing costs attached, but these fees will be added to the loan in the form of higher interest payments. Alternatively, the closing costs may be rolled into the mortgage, which means the borrower will be paying interest on these payments throughout the life of the loan.
Refinancing when rates are low can help some homeowners save hundreds of dollars each month, but be sure to look at the full picture before going ahead with a refinance.