During a low-interest rate environment, aggressively refinancing your mortgage can help lower your pesky interest-rate payments to be able to invest the leftover proceeds, sweep that liability under the rug, become debt free and have full equity + ownership in your home.
It only seems like a great financial decision to lower your monthly payments.
A mortgage payment is comprised of 2 parts: the repayment of principal and the interest expense that is charged by the financial institution holding the mortgage. The principal repayment goes towards the paying down of the original purchase price of the home and the interest is the expense charged to borrow money over time.
If youâve received a windfall, extra bonus or boost in salary, it may be tempting to stash it into the market right away yet one is predictable and one isnât. Read about which decision is better: paying off the mortgage or investing it instead.
Youâll be surprised.
Put yourself in the banksâ shoes. If someone wanted to borrow money and pay you back in 30 years, you would likely charge a higher rate due to the time value of money, decreased spending power due to inflation and the risk of default if something happens to the borrower. On the other hand, if the borrower asked to borrow money and pay you back in month, you might not want to bother charging interest.
As a result, longer maturities, higher yield.
Refinancing Mistakes
Refinancing sounds cheap, a great way to save and the easiest alternative to pay off your mortgage faster. Yet when it comes to the time value of money and how long you plan on staying put in your home, it might be the dumbest choice you make as a homeowner.
Here are the reasons why refinancing wonât work and only cost you more:
#1 Lock in a lower rate with additional closing fees
As with your initial mortgage, youâll have to pay closing costs when you refinance your home. Closing costs typically amount to thousands of dollars and it can take a long time to offset those closing costs. In addition, depending on the amount you are borrowing, in certain states, you have to pay the state a percentage (mortgage tax) on the amount you borrow.
#2 To move into a longer-term loan
If you only have a few years left on your mortgage, it would be pointless to pay the fees discussed above. Plus if you play to stay in the home long-term, you donât want to stretch those remaining payments because youâll end up paying more in interest by extending your loan term.
#3 Switch from fixed-rate to adjustable-rate mortgage
Fixed-rate mortgages lock in your rate for the entire life of your loan.
ARM(adjustable rate mortgages) lock in your rate for the first few years, then change your rate periodically, an alternative you might want to consider instead.
ARMs vs fixed rate mortgages have their pros and cons used in different scenarios. You may be tempted to refinance from a fixed into an ARM so you can score lower rates for the next few years and have lower monthly payments in the short term yet itâs an unwise move long term because even if the payments are fixed for a period of time that you can measure, you donât know where the economy will be once interest rates fluctuate.
Adjusting a mortgage is only wise if you know/expect your income to rise and have enough cash to pay it off quicker. Otherwise, youâre depending on the economy which isnât always great considering that a recession happens every 8â10 years and whatâs certain is uncertainty.
#4 Invest In The Market
Most people refinance to:
-Cash out and invest the money in the market
-Make lower payments and invest the monthly savings into the market
The market is unpredictable. Who knows if it will outperform your home. Maybe farmland or NFTs will because theyâre alternative investments but real estate can be as volatile as the stock market, especially considering itâs at itâs peak with too high demand, low inventory and approaching a possible bubble contributed by inflation.
#5 Make Sure You Donât Go Crazy With Cash
Cash-out refinances are smart if your home has gained value since you purchased it and you are looking to tap into your home equity to pocket money for other expenses. If youâre going to cash out to consolidate debt, lower your monthly payments and reducing the interest rate then do so yet if youâre looking for cash for no reason, then thereâs no reason to waste your heard-earned equity.
#6 Offset Financial Losses
Refinancing or a switch over to an ARM is best if you suspect you will loose income soon and not be able to afford the monthly payment. If you are unsure about your financial situation and still recovering from the pandemic, refinancing to cut costs is smart but not possible if your credit worthiness is not up to par and you must prove steady income for the refinancing process.
Just because refinancing sounds cheap and efficient doesnât mean you are right for it especially if your other finances such as debt to emergency cash hoard arenât in order.
Assess why you may need to refinance, how long you plan on living in your home and whatâs bugging you about your mortgage to identify whatâs the best solution.
And as a reminder, the best way to handle your finances is NOT by equating your emotions to your decisions, not letting others sway you and sleeping on any major preferences, preferably for several days.