When you refinance your mortgage you pay off your existing loan and replace it with a new loan. Homeowners do this for many different reasons: to consolidate a debt, to obtain a lower interest rate, to shorten the term of their mortgage, to convert an adjustable-rate mortgage to a fixed-rate mortgage, or to use their home's equity to finance a large purchase. Whatever the reason may be, the homeowner should examine the benefits and possible drawbacks since a lot of factors are involved in refinancing a mortgage. Some reasons for refinancing can be financially sound but it can present a slippery slope of never-ending debt.
Some homeowners make use of the equity of their homes to cover big expenses, such as home improvements or college. Home improvements and remodeling can add to the home's value. Another possible benefit is that the mortgage interest may be tax deductible.
Many homeowners refinance so they can consolidate their financial debt. On the outside, a high-interest replaced by a low-interest one in the form of a mortgage appears like a good idea. But when you look at the reality behind it, refinancing does not bring financial wisdom. If you are in the habit of using credit cards to buy things you do not have the income for, you are likely to do it again after the refinance. The new mortgage will give you greater access to the unsecured credit that you refinanced into your mortgage in the first place. This creates a larger problem than the one you started out with because you now face wasted refinancing fees, the loss of equity in your house, and more years of payments with interest on the new mortgage.
Should you refinance? The answer here is simple. Refinancing is a good financial idea if it will reduce your payment on your mortgage, help you build equity quickly, and shorten your loan term. It becomes a matter of more careful consideration if only one or two of those criteria are met.
One other very important question to ask is: "How long do I plan to live in this house?" Generally, refinancing costs between 3 and 6% of the principal amount of your loan. It will take you several years to recoup that cost with the savings you will generate from having a lower interest rate or a shorter term. So if it seems likely that you will move soon, it does not make financial sense to refinance.
If you use refinancing carefully, it can be a very valuable tool in getting your present debt under your control. A prudent homeowner is looking for ways to reduce debt, build equity, save money, and eventually eliminate the mortgage payment. Deciding to take cash out of the equity of your home for unnecessary expenses through a refinance will not, in any way, help you in achieving your goals.
A mortgage is actually a liability that is deducted from your assets in determining your household's actual net worth in the market. Too many homeowners fall into the trap of thinking that lowering their monthly payments through refinancing is the only consideration, and they often end up not realizing how refinancing can affect their net worth. It is wise to think things through, ask the experts, and do a lot of research so you do not end up in a financial mess.
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