RATES ARE LOW But is refinancing a bad idea?

Record low interest rates create another refinancing boom. Banks and brokers benefit big time, but what about you and me? Just because your interest rate goes down doesn’t mean you’re saving money. Refinancing could look good and still hurt you. Sometimes refinancing can save you thousands of dollars and get you closer to your goals, but is it always a good idea? Here are five reasons why refinancing may be a bad idea.

1. Extended Break-Even Periods – When looking at a refinance, I start with break-even. This is the point where your monthly savings cover the cost of taking out the loan. To calculate this, take the cost of the refinance, which will include all 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 to recover the costs.

I recently refinanced a couple of properties with a breakeven point of almost four years. That’s normally a lot longer than I’d like to see, but I never plan on selling these houses, so I have a high level of confidence that I’ll still have them after four years. I didn’t think I would have a chance to secure the rates I did, so I did. Knowing that my break-even point is about four years, I know it’s all savings for me after that.

2. Closing costs can be high: I was surprised by the costs of taking out the loan with my last refinance. These were smaller loans, so with fixed costs such as appraisals and closing fees, the total closing costs as a proportion of the loan amount were high. Granted, you can most likely include the costs in the loan, but even that comes at a cost. Transferring closing costs to a loan means you’ll pay interest on those charges for the next 30 years.

Be sure to review your cost estimate from the lender and question the fees. Do this before you commit to the loan and before you order the appraisal. There are also often ways to lower your interest rate by increasing your closing costs. These are called “rebuys.” Review your purchase options with your lender and see what the break-even point is for each option. Often, sticking with a slightly higher rate is necessary to keep closing costs down.

3. You’ll End Up Paying More Interest – Amortization schedules are a great thing for keeping payments consistent over the life of the loan, but they create a devastating downside. Have you ever looked at your mortgage statement to see how much of your payment goes toward principal? Repayment schedules, while necessary, hurt borrowers in the early years of the loan. Most of your payment goes toward interest and very little goes toward paying off the loan. As you progress through your repayment schedule, you’ll notice that more and more of your payment is applied toward paying off the loan. In most cases, with a 30-year loan, you have to wait more than 15 years before half of your payment is applied toward principal. One major downside to keep in mind when refinancing is that you’ll reset your amortization schedule and start over, meaning the bulk of your payment will once again be applied to interest.

4. Extended Payment Periods: This is true for several reasons. First, as we’ve discussed, you’ll most likely defer your repayment schedule, which means you’ll pay more interest each month, but that also means you’ll make your loan payments over a longer period of time. Every time you refinance, you may be further and further delaying the time it will take to pay off your loan.

5. Debt Consolidation Won’t Automatically Save You Money: Debt consolidation can have a huge positive impact on borrowers. Especially with monthly payments and a plan to pay off the debt. 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 the debt. Sometimes moving these debts into a refinance is the only way forward, but be careful. By doing this, you are extending the debt to 30 years and have the ability to use your cards again, which would put you in a much worse situation.

The subject of debt consolidation is complicated. It is often best to get help from a professional. Even when the loan seems to benefit you, it may not be, or if it seems to hurt 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 great benefit in the long term. In this example, we made a loan with no prepayment penalty and no fees. No-cost loans are possible with higher interest rates. We eliminated all of her credit card debt, which was significant, and that raised 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 again, saving him over a thousand dollars a month. Your short-term increase in payment 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 tremendous benefits. It allows you some flexibility to speed up your payment schedule, it can lower your 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 your traditional lenders and banks, but if you need to free up cash to complete a construction project, you may want to consider hard money. Hard money lenders can be expensive, but they can get you the cash you need when you need it. They also get you to the closing table fast. When done correctly, a hard money refinance will get you over the finish line.

It is important to see the disadvantages of refinancing a property to make the best financial decision. Understanding rates, terms, and repayment schedules are important in analyzing the deal and making your 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.