The decision to refinance may seem like a simple one; a lower interest rate is, after all, a lower interest rate; however, there are several good reasons not to refinance. In fact, in some cases, refinancing can actually cost you more in the long run:
1. HOW LONG HAVE YOU HAD YOUR LOAN? First, consider how long you have had your home loan. If you are 10 or 20 years into a 30-year loan, refinancing could significantly increase the amount of interest you pay during the life of the loan, especially if you had structured your initial home loan so you paid the interest first. Then, if you refinanced, you would end up paying interest twice!
2. IS YOUR CREDIT WORSE NOW THAN IT WAS WHEN YOU TOOK THE LOAN INITIALLY? Also, take a hard look at your credit score. If your credit is worse now than when you had taken out your home loan initially, you could be setting yourself up for a higher interest rate than you have now. Just because you see mortgage refinancing rates advertised at 4 percent (or even lower), it does not mean you will qualify for that low rate. Moreover, lenders are using low rates like that to attract people with good credit; if your credit is less than perfect, you could still end up with an interest rate as high as 12 percent.
3. DO YOU HAVE AT LEAST 80 PERCENT EQUITY IN YOUR HOME? Further, make sure you have enough equity in your home to get the best rates; you will need at least 80 percent. If you have been paying on your loan a while, this may more likely than not, but you have to consider the current value of your home. In today’s market, with property values as low as they are, you may not have the 80 percent equity you need to get a good rate.
4. DO YOU LIVE WITHIN YOUR MEANS? You should take a look at why you want to refinance as well. If you are just trying to withdraw equity or lower your monthly payment, you need to ask yourself whether your spending habits are an issue. Using the equity in your home like a checking account or credit card is a bad idea, especially if you want the money (or a lower payment and therefore more money per month) just to be able to spend more.
5. DO THE COSTS OUTWEIGH THE BENEFITS? Lastly, take a hard look at the costs involved. While the interest you pay on your home mortgage is tax deductible, closing costs are not. As such, if refinancing saves you $2,500 per year in interest, and if closing costs are $10,000, it will take you 4 years to break even.