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Should you Refinance? The Mistake People Make?

January 25th, 2008 at 12:32 pm

With all the news about the Feds dropping the rates (and it's not over yet), people are being encouraged by the media to refinance. I've seen several and heard several news clips about refinancing your mortgage.

While for many people who have high interest rates,this is a good idea. If you can shorten your term and keep your payments manageable, that is a huge savings. If you can even refinance your current mortgage and keep it on track and save money, that is a good thing too.

When deciding to refinance there is a mathematical way to determine if it is right for you. In my state it would generally cost about $2,300 to $2,500 for the average borrower, with no points. Closing costs must be considered when determining if there is a savings. Generally I take the current payment on their existing mortgage and multiply that by the remaining amount of payments. Otherwise borrower has 240 months left at $500 principaland interest (240 x $500 = $120,000). Then I take the new proposed mortgage and multiply the payments by the amount of months to pay, and add the closing cost and you will have the savings. Example would be 240 months at $350 plus $2,500 closing costs (240 x $350= $84,000 + 2500 = $86,500; savings $120,000 - $86,500 = $33,500). Then we decide if it is worth it? If it is only a few thousand dollars it would not be worth it.

I get concerned when a client comes in with a slew of credit card debt and they want to put it into their mortgage to make monthly total debt more comfortable. Otherwise, take unsecured debt and make it secured and jeopardize your real estate. Unfortunately, most customers that choose to do this usually come in two or three years later in the same situation again.

My feeling is that if a customer can get an unsecured line of credit to clean up their credit cards and can stick to a plan to pay off that line, they should not refinance into their mortgage and secure that debt.

Lets face it, many people live paycheck to paycheck and if there were a major loss in their life; loss of income, death of a spouse, illness and etc., they would most likely be in financial trouble. If you get in trouble financially you want to pay your mortgage first keeping a roof over your head and providing for you and your family. If you have piled all of your unsecured debt into a mortgage, then you are paying it all and may have put yourself in a worse position.

If your financial position went bad,so bad you had to file Chapter 7 bankruptcy because your income was lost or you lost an income in your household; divorce or the death of a spouse, you would not get the financial relief of wiping out the unsecured debt that gives you a "fresh start" if it is wrapped into a mortgage and secured by your real estate.

I have heard how things are economically across the country, but what I know best is what goes on here, I live in a very rural area were unemployment is the highest in the state, poverty lives here and we have a food shelf in every town to provide for the needy. Most people here have a combined income of about $40,000 to live on. We have one of the best assistance programs in the country offering affordable housing, fuel assistance, health insurance and etc. We also offer education programs to get people off assistance. For the average income, houses sell from $80,000 to $150,000, but most people I work with are living from paycheck to paycheck and have very little savings. Our state offers 100% financing on a primary residence if your credit score is 660 or better and you have had at least three tradelines (auto loan, credit card, student loan and etc.) and have paid as agreed,to low and moderate income borrowers and the state program will pay their closing costs.

Most of these clients have nothing to fall back on since they have no savings generally. They will not be eligible to refinance for about five years, they have to wait until their equity is there. So five years later when one of these clients come in with a stack of credit cards and want to refinance, I feel it is a major step backwards, putting unsecured debt on to their home and jeopardizing their financial position,when you know that one major event could put them into bankruptcy and they would not get the relief they could have gotten because their unsecured debt is hidden in their mortgage. Now the relief they could have had is gone and their mortgage payment is higher, maybe too high to pay, and they end up lossing their home in foreclosure.

That is why I feel it is my professional responsibiity, in my business, to caution each and every client that tries to refinance their unsecured debt and make it secured against their real estate. Do not do it if you can avoid it, it is usually just a bandaid that allows you to continue spending out of control and I will see you again in another five years. Being in this business for 22 years, I have a list of habitual debtors that come back time and time again.

Give them the knowledge to make a decision and sadly, many still want the refinance. Unfortunately, you cannot borrow your way out of debt, I know that better than anyone else.

These are just my thoughts on the subject of refinancing and I know there are many responsible people out there that know how to handle their finances. I'm not trying to offend anyone, I'm just trying to make an awareness of the situation.

Many lenders will not go through this exercise with their clients, they just let them do what they want without any advice because it brings in money to the bank. I guess this is my personal advice for people who are spiraling out of control in debt. Fix the problem, don't continue it by refinancing your home.

Bad things do happen to good people and you need to think through your debt restructure plan and see if is a bandaid or a fix.

4 Responses to “Should you Refinance? The Mistake People Make?”

  1. Broken Arrow Says:

    Another very good article. Sobering food for thought.... Thanks for sharing!

  2. disneysteve Says:

    "If it is only a few thousand dollars it would not be worth it."

    Why not? A "few thousand dollars" is a lot of money to most people. I ran some numbers the other day and estimate I can save about $6,500 and shorten my loan term by 5 years if I refinance at current rates (including the closing costs). If the rates drop lower, which they probably will, that savings gets even larger. I'm willing to do the paperwork to save a "few thousand dollars."

    I agree with not rolling CC debt into the mortgage. Most people who do that are right back in CC debt within a year or two and are even worse off than they started.

  3. lost in debt Says:

    When you are shortening your term and you saved $6,500 - is that minus closing costs? Then I would go with that, but wait another month here, it's going to take that long for the rates to calm down. When I refer to a few thousand, I meant $2,000 to $3,000 - it makes more sense to try to pay off your mortgage faster than refinance. If you make one extra principle and interest payment on a 30 year mortgage per year, you will cut seven years and thousands of dollars off your mortgage.

    Broken Arrow; Thanks for the compliment.

  4. disneysteve Says:

    "When I refer to a few thousand, I meant $2,000 to $3,000 - it makes more sense to try to pay off your mortgage faster than refinance."

    Why? I'd say the way that makes the most sense is probably the way that saves the most money. Prepaying the mortgage means spending more money to shorten the term. Refinancing means spending less money to shorten the term (even with closing costs included). To you, saving $2,000 or $3,000 may not be worth it but I'm sure to many others, saving that much would be very much worthwhile. But I agree that everybody's sense of what is worth it will be different. I probably wouldn't bother for $1,000 but probably would for $3,000. Someone else might do it for $1,000. All depends on your situation.

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