Refinancing your home is a big decision. How do you know if it's right for you?
The truth is, there's no perfect set of guidelines or one-size-fits-all rulebook when it comes to refinancing your home. But if you really want to make sure you're doing the right thing (for the right reasons), you may want to ask yourself a few questions:
1. Why are you refinancing your home? This sounds like a no-brainer, but it's not as straightforward as it sounds. There are dozens of reasons homeowners consider refinancing, and some aren't as solid as others. If you're refinancing your home to help pay for your teen's college costs or to escape an adjustable-rate mortgage (ARM), you're probably doing the right thing. On the other hand, if you're refinancing your home to pay off your massive amounts of credit card debt, well . . .
2. Will refinancing help you - really help you - in the long run? If you're refinancing your home because you're drowning in credit card debt, first make sure that you've made the commitment to change your spending habits.
Refinancing in order to pay off credit card debt is not necessarily a "sound" reason to do a refinance. The biggest problem is that you are taking unsecured (credit card) debt and trading it for secured (mortgage) debt, ultimately that could cost you your home, if your finances got really ugly. The other major problem with this is that most people who refinance their homes to pay off credit card debt don't tend to learn anything about living within their means: They end up owing more on their home, and they usually go right back to racking up credit card debt: after just 18 to 24 months, many end up owing the same amount again on credit cards.
Don't let your refinance turn into an excuse to spend more.
3. How long will it take to break even? When you refinance, you are responsible for paying fees and closing costs associated with your new loan (for most homeowners, this comes out to be around $2,000). Before you refinance, you should run a few numbers to determine your "break-even point" – that's the amount of time it will take you to recoup what you have paid out.
To find your break-even point, you simply divide your mortgage fees by the amount of money you're saving each month. Say you saved $120 a month by refinancing your home, and you paid $3,000 in closing costs and other fees:
$3,000 (closing costs)/$120 (monthly savings) = 25
In this example, your break-even point is 25 months, or just over two years.
Of course, you should keep in mind that if you're lengthening the terms of your loan, you may be doing more harm than good. This can be an issue when people refinance in the hopes of lowering their monthly payments . . . but end up extending the life of their loan by another five years or so. In cases like this, the interest costs you'll end up paying probably aren't worth it - especially if you intend to live in your home for the long haul.
4. Is your credit (still) good? Or, more to the point, is it as good or better than it was when you got your original loan? If you've hit some hard times, financially, your credit score may not be what it once was. Before you try to refinance your home, consider your current credit: Do you have any new debt? Late payments or delinquencies? If so, you may not be able to get a low enough interest rate to justify a refinance. You may be better off with your current mortgage.
5. Have you done your homework? Before you seriously consider refinancing your home, you should make sure you're making an informed decision. Shop around with several different lenders (of course, you should check with your current lender, too - most banks want to keep their customers) and read up on the costs and benefits of refinancing. At the end of the day, you are the only person who can decide if refinancing is the right way to go.
--- Michael G. Peterson co-founded American Credit Foundation, a non-profit credit counseling organization. Visit debtguru.com for more information and financial resources.