Refinancing or not can make your home a better investment
One of the results of a recent study on homeowners and financial outcomes found that how homeowners refinance has an effect on whether homeownership is a means for building wealth (read more about how to make your home a good investment). It turns out that refinancing or not is a big factor.
First of all, what is a refinance? A refinance is simply getting a new mortgage. The bank you are getting the new mortgage from pays off your old mortgage with the amount that you are borrowing from them, and you have a new mortgage with a new bank.
You can get any kind of new mortgage. You could get one with a different product, a shorter term, a longer term, and even get cash out (called a “cash out” mortgage where you refinance for a higher loan amount than you owe, getting the difference, minus the fees, in a check).
There are also many reasons that people refinance. The most common reason that people refinance is to save money on a monthly payment. If interests rates drop, refinancing can lower your payment. You can also lower your payment by extending the length of your loan. Another reason people refinance is if they want to pay their mortgage off faster. They may choose to shorten the term of the loan.
What should your strategy be?
To maximize your home as an investment, it’s best to pay the least amount of interest and pay as much principal as possible so that more of your hard earned money is going to paying down your loan and not just to the bank.
That’s kind of a no-brainer, right? But, here’s where it gets complicated.
A common rule of thumb is that you should refinance when rates are low.
But, consider this: with the way that amortization works, in the beginning of your mortgage, you pay the largest proportion of interest, and as the years go on, you pay less and less interest, and by the end of the 30 years, you pay hardly any interest at all.
Let’s say that you are several years into paying your mortgage. You go online to a mortgage calculator, punch in your numbers, and it says you can save money on your monthly payment. Hurray!
But, by refinancing, you are going to be starting over again at the very beginning of a mortgage where the proportion of interest you are paying is the greatest, so unless the difference in interest is significant, you could STILL end up paying more interest than you are now.
But who cares, you are saving money, right???
Not so fast. If most of your monthly payment is going to interest, you are building up equity very slowly in your home. That equity is your money – what you get back when you sell your home. Yes, you may have lower monthly payments but you could also get a smaller check when you go to sell your home.
Still think you are saving money?
Also, most online calculators assume that you are refinancing into another 30 year mortgage. If you are several years into your current mortgage, by refinancing, you made your 30 year mortgage into a 30+ year mortgage. Longer mortgages mean higher interest payments.
Know your options
The good news is, there are many options available to you. The bad news is, you won’t always know about them. That’s why I made Refinance Yourself so that people can explore all of their options and see how they affect their interest, principal payments and home equity before they go to a loan officer.
Best of all, it’s totally unbiased and for a very limited time free. The only thing I ask is that you give feedback in return, in the form of a 15 minute interview at the end.
Considering a refinance? Don’t refinance without knowing your options from a totally unbiased source.