October 30, 2018
If you’ve seen ads for attractive interest rates, are feeling “house rich yet cash poor,” or want to make a dent in your credit card debt or student loans, you may be mulling over whether it makes sense to refinance your home.
Homeowners tend to refinance for one of three reasons, says Abel Soares III, CFP®, owner of Ekolu Tax & Consulting, PLLC. They refinance to “shorten the number of years to pay off [their mortgage], to decrease their interest rate, or to open up monthly cash flow in their budget.”
Regardless of why you’re thinking of refinancing your home, it’s important to know in which cases it can be a smart financial decision and in which scenarios you may be taking on additional (and, possibly, unnecessary) risk.
The reasoning behind refinancing will be different for every homeowner.
“I had a client who bought a one-bedroom starter home in San Diego,” says Sahil Vakil, managing director, MYRA Wealth. “They put a 30% down payment when they bought it and lived there for about five years, building equity. Then, they were having a second child and needed a [larger space]. But they still loved their current home and San Diego’s rental market is pretty good. They did a cash-out refinance with the existing equity and down payment, then took that cash as a down payment for the [new home]. There are caveats to this approach: You need to have the income to substantiate owning both homes, which they did, but it [enabled them] to move forward.”
Rich Carroll, CFP®, founder of First Ascent Financial, had clients with $12,000 in credit card debt. “One of the spouses was self-employed and the business was not quite as profitable as had been expected for that year,” he says. “They were at a 15-year mortgage, which was great, but they were really feeling the pinch of making the budget work. So, we were able to refinance them into a 20-year mortgage. They ended up paying a little more in interest, but they were able to knock out the credit card debt and make the [mortgage] payment more doable.”
Look at your income and long-term plans. Compare the terms of the potential refinanced mortgage with your current budget and mortgage.
“Typically, it’s one of three variables to adjust,” says Vakil. “With interest, you always want to decrease it, never increase it. With the loan amount and time frame, you can increase or decrease, depending on the client’s life stage and their situation.”
As always, “make sure to run the numbers [so it] benefits you and you have a purpose for any funds that you are saving,” says Soares.
Refinancing tends to get risky if homeowners are considering it as a short-term solution and/or to offset problematic behaviors.
Martha S. Williams, CFP®, president and founder of Williams Wealth Services, formerly worked as a mortgage originator and saw many homeowners get into trouble. “Far too often, clients were willing to use their homes as an ATM to finance a lifestyle that wasn’t sustainable,” she says. “Most people who use their home to pay off current debts are not living within their means. Paying off old debt with a mortgage refinance may not change the behavior that got them to that point.”
Carroll also emphasizes behavioral change first and foremost. “I want to make sure that we fix the problem and that [refinancing] is not just a one-time solution,” he says. “You really need to focus on how you’re managing your budget and cash flow before you refinance because if you don’t handle the main issue, if it’s an overspending issue, then you’re just going to end up in the same situation—and now you have that much more debt.”
It’s also imperative to do your due diligence with your lender, says Vakil, so be sure to check for large origination fees, points, and/or prepayment penalties. Compare fixed versus variable rates in terms of what you’re hoping to accomplish with the refinance (especially with your time horizon). Go through the fine print of any refinancing agreement to make sure you don’t have any surprises down the line.
“It really helps to get a referral from someone you trust,” says Williams. “That could be your financial advisor, tax preparer, or Realtor®. All of these professionals have contacts with trusted mortgage professionals to help with the process.”
Consult with your trusted professionals often: No question is unwelcome. Always remember your original goals and why you were considering refinancing in the first place.
“Refinancing is not like a silver bullet, but it is a tool to help you feel less overwhelmed,” says Carroll.
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