Is Refinancing Right For You?

Refinancing is the process of paying off an old debt by creating a new debt. It is most typically used with mortgages. When is refinancing the right move, and when is it not?

Refinancing typically is beneficial to a borrower when they are getting a significantly lower interest rate. Refinancing a debt of $100,000 at 8% to 4% would save the borrower $477 a month. But even this type of refinancing can be a bad decision under certain circumstances. A $100,000 debt that is going to be paid off in ten years should not be refinanced into a new thirty year loan. Although the payments may be lower, the borrower will end up paying twice as much thanks to interest, even if the interest is at a lower rate. With only ten years left, the borrower is probably not paying a large percentage of interest with each payment, meaning they are paying down their principal debt and building equity. The borrower would be better off focusing on paying off the debt. The banks encourage refinancing so the borrower will always be making payments. They also tend to charge fees when they refinance a loan. These fees can eat up the savings of a refinance. They may charge origination fees, appraisal fees, title fees, and closing fees.

Some borrowers choose to refinance their mortgage into a line of credit. This can be dangerous since interest rates are usually variable, and if the borrower uses the line of credit, it is putting the debt against the home. Using the line of credit for buying a car or vacation is a risky purchase when using your home as collateral. With interest rates at their lowest in history, there's a strong chance interest rates could climb significantly in the future, especially if the Federal Reserve feels a need to fight inflation.

Some borrowers will refinance all of their debt into one easy payment. This can be a good idea if the borrower will have a much lower monthly payment, but the borrower needs to close those other accounts, or risk getting into more debt. What might have seemed like a good idea could cost them their home.