Refinancing Red Flags: Too old and Too Long?
I have already blogged about the most important considerations that must be accounted for when deciding whether to refinance a mortgage. With this post, I would like to focus on a few “red flags:” attributes that should cause you to think twice about a re-fi.
The first red-flag is time. From a mortgage duration standpoint, it probably doesn’t make sense to refinance if you are close to (or already passed the halfway point) of your mortgage. For example, if you are 15 years into a 30 year mortgage and refinance into a new 30 year mortgage, you will incur significant additional interest, by effectively lengthening your amortization period by another 15 years. For a modest $200,000 mortgage, this translates into a whopping $60,000 of additional interest payments.
In this case, a better option would be to refinance into a new 15-year mortgage, the net result of which would be no change in the amortization period. If you’re considering such an option, it makes sense to first speak to your lender, who might be willing to modify your interest rate without compelling you to take out a new (i.e. refinanced) mortgage. If a loan modification isn’t an option, the next consideration is how many years you plan to live in your current house. Most experts use two-years as a benchmark; in other words, if you are planning on moving out within the next two years, it will be difficult for you to recoup the closing costs associated with the refinancing.
Red-flag number 3 is your age. If you are nearing retirement age, it probably doesn’t make sense for you to refinance, because then you ensure that you will be making mortgage payments from your savings/pension well into retirement. Who wants to be saddled with such a burden? The only exception is if you have already refinanced in the past and/or have very little equity in your home.
Instead, you might want to consider a reverse mortgage (see yesterday’s post), which allows you to pay off your current mortgage and essentially freeze the equity in your home at a given level (usually no less than 35% of the value of your home) and cash out the difference. As long as you don’t plan to move out/sell your home in the short-term (in which case you “forfeit” some of the proceeds), a reverse mortgage will allow you to remain in your current home indefinitely without having to worry about making mortgage payments (that you would otherwise still be making after refinancing your mortgage).
The final red flag is that you are refinancing for the purpose of debt consolidation/consumption, rather than to save on your monthly payments as a result of a lower interest rate. In recent years, cash-out refinancings have become very common, but I implore you to resist the urge, unless absolutely necessary. It can certainly be tempting to roll all of your credit card debt, auto loans, etc. into your mortgage, which almost certainly has a lower rate. But think of the implications of this: in doing so, you are essentially amortizing the dress you just bought or your car (both of which have limited time use) over 30 years! Besides, if the value of your home goes down, you are now personally on the hook for the difference.