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Refinance Is Not Right For Everyone

[May 20, 2008.]


Refinancing your home should never be a snap decision. To many homeowners, it seems like simply a question of asking themselves if interest rates are low. If the interest rates are lower than when the homeowners made their initial purchase, then, immediately, the temptation is to refinance. Unfortunately, the question of whether or not to refinance a mortgage is never that simple. Even when interest rates are low, refinancing isn't right for everyone.

Who, in particular, should beware of refinancing their home? Those who have  become heavily indebted since their home purchase, those who have more than one mortgage, and those who are struggling with making mortgage payments in a timely manner should all beware. These kinds of homeowners might actually lose money from refinancing in the end, and often would be better off keeping their old loan.

One factor a you should consider before deciding whether or not to refinance is how much equity you own in your home. Your equity stake does much to help determine your likelihood of acquiring a more favorable loan. If you borrowed 95% of the value of the property, it doesn't make any sense to refinance after, for example, only a year or two. Refinancing a loan entails special closing and transaction charges. If your equity stake hasn't increased since you took out the loan, refinancing—with its associated costs and charges—may causing you to lose more money than you will gain.

Credit history is another factor for you to consider. Mortgages can often put poorer homeowners under considerable financial strain. Some strained homeowners resort to other loans to help pay off the mortgage, such as equity loans. They may have used up more of their equity as collateral for these loans than they actually have. If you are in a situation like this, banks may hesitate before offering you the rates you want when you try to refinance.

Even if you have adequate credit, you're not off the hook. A homeowner who has taken out a loan for more than 80% of the value of the home he or she bought is likely to have to pay private mortgage insurance. Lenders will make borrowers pay the cost for this insurance, which is designed to protect the lenders, regardless of the borrowers' credit rating.

Thus, if the loan you are trying to refinance entails borrowing more than 80% of the value of the home, the cost of private mortgage insurance will be added to the other costs that you will have to pay. This added cost makes it harder to save money by refinancing.

Finally, refinancing is potentially disadvantageous to homeowners who've been paying off their mortgage for a long time, in addition to those who are are just starting to make payments. Why? If you've been making payments for 25 years on a 30 year loan, refinancing for another 30 years  will let you pay off the mortgage in much smaller increments—however, you will pay so much more in interest that you will lose money. It's smarter to just keep paying off the same mortgage in the same increments as before for another five years.

So, in short: don't automatically assume refinancing your home to be good thing. Calculate exactly how much you'll be spending on your existing mortgage first, and compare that number against exactly how much you'll be spending you any potential refinanced mortgage.


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