Refinancing the Right Way

Home loan rates have been low for quite a while and the temptation might be there to pull some equity out of your house and pay off your other, higher-interest debts. Mathematically, it sounds like a good idea.

But is it?
Refinancing is something you must be careful with for the simple reason that, when you do it to pay off debt, you are putting your home at risk. You are leveraging the place you, your spouse and your kids sleep. If you lose your job or encounter financial difficulties, guess what you risk losing?
That’s not the only reason to be wary. The vast majority of people who take equity out of their home to pay off bills don’t change the behavior (overspending) that led to owing money in the first place. That means the credit card balances are run back up, and when you combine that with your higher house note, you end up in double debt.
Don’t pull money out to do renovations on your home. When you use your equity for any purchase at all, you are then on the hook for that money. You owe it. If you don’t pay, there will be trouble.
The time to refinance is when you want to make a less-than-desirable mortgage better, not when you want to buy something with that money. Refinancing might be good if:
  • You have an adjustable rate mortgage.
  • You have an interest-only loan.
  • Your house note goes for more than 15 years (such as 30, 40 or 50 years).
  • You have a high interest rate.
In each of those scenarios, you are not pulling money out of your home to use elsewhere. You are modifying your current mortgage to more favorable terms, be it a lower interest rate or a shorter note. If you do it, your new payment should be no more than a fourth of your take-home pay on a 15-year fixed-rate note.
A way to gauge the numbers is to do a break-even analysis. That means dividing your costs of the loan by the savings that result from it. The number you get is how many years it will take to pay off the debt. If it will take you longer than that to pay it off, then refinance. If it will take you less time, then you’d pay too much in closing costs and fees to justify it.
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