Refinancing? Beware of Conventional Wisdom
Consumer advocate Marc Eisenson is probably best known as author of The Banker's Secret, the "bible" on mortgage pre-payment. Marc wrote the following article at our request -- as a warning to all who visit here hoping to refinance their mortgages. It's a great example of the advice you'll find in Marc's -- and frequent HSH.com contributor, Gerri Detweiler's -- new book, Invest in Yourself: Six Secrets to a Rich Life.Order it online at the Good Advice Press site!
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With interest rates on a downslide, you're visiting HSH.com because you're tempted by the lower interest rates. Refinancing seems like a great way to save money. In fact, you're smart to be tempted to refinance. You'd be nuts to pay some bank more of your hard-earned money than you have to in interest. But don't make your decision based on conventional wisdom. It may cost you a fortune!
Conventional Wisdom #1: Refinance when rates have dropped 2%.
Real Wisdom #1: Invest the time to think through how long you're likely to live in your house -- or your refi may easily cost you more than sticking with your current loan. You gotta crunch the numbers from time to time. Now that the rates are so low would be an especially good time!
The right time to refinance is when easy calculations show that you'll save money -- forget about the spread in rates! The longer you intend to be in your current home, the less rates need to drop for you to save money. Sometimes, less than a 1% drop will save you money. Here's how to figure that out:
Ask a lender, go to www.hsh.com/pamphlets/refi.html or use a software program (like my Banker's Secret Loan Software, $42.95, 800-255-0899, www.investinyourself.com/tbs2.htm) to calculate the total cost of your current loan -- between now and when you plan to move (say in 7 years)-- not for the remaining term of your loan.
Then do the math for a new loan with the same term, but at the lower rate you could get now. (Add closing costs to the amount you'll be borrowing.) For detailed instructions, see "Buying the Right Mortgage -- New or Refinanced," beginning on page #242 in my new book, Invest in Yourself (1998, Wiley, $22.95).
Conventional Wisdom #2: By refinancing you'll be saving money every month!
Real Wisdom #2: To really save money, invest at least as much money in your new refi as you do in your current home loan. While refinancing reduces your monthly payment, it also typically stretches out the term of your loan -- which can dramatically increase your total cost. That's because the heaviest interest charges are at the start of the loan, and beginning a new loan means making those high interest payments all over again. And if you take the full time to pay off the new loan, refinancing could easily cost you more than sticking with your current loan.
Conventional Wisdom #3: To save the cost and hassle of refinancing, just pre-pay on your current loan. You can save thousands.
Real Wisdom #3: Investing in your mortgage always makes sense to me! Whether or not you refinance your current mortgage, it's true you'll save thousands (perhaps tens of thousands) by paying as much over the required amount as you can, whenever you can. But that doesn't mean you shouldn't refinance! It's worth an investment of your time to save your family a fortune.
At least run the numbers. If your number crunching indicates that refinancing will save you money, do it! Then pre-pay by sending in at least as much as you had been paying before you refinanced. By combining refinancing with pre-paying, you can quadruple your savings from refinancing alone.
Conventional Wisdom #4: Consolidate all your debts with a refi. "You'll lower your interest rate and lower your monthly payments," say the ads. "There'll only be one payment, and there might even be tax deductions. How can you lose?"
Real Wisdom #6: Invest the time to look at your spending habits and lifestyle -- before you buy the sales pitch from some baseball has-been on TV. Are you really ready to stop charging, or are you going to start running up those credit card bills again?
If you're ready to stop buying things you can't afford, and the numbers show that you'll save money, by all means, go for a debt consolidation refi. Be sure to send in as much money on the new mortgage as you had managed to send in on the old mortgage and all those bills combined.
Don't be surprised, though, if you'll have to pay slightly higher interest than the going rate. Why? Because lenders believe that people who borrow more than the amount they owe on their current mortgage are more likely to default.
If you're likely to run up balances on your credit cards again, you may end up in BIG trouble. What would happen if you lose your job? You'll have even more bills to pay, less home equity, and you might even face the threat of foreclosure.
Never take out a loan based only on the monthly payments. In fact, never buy anything based only on the monthly payments -- unless you really get off on paying too much for things.
Conventional Wisdom #5: Refinance and borrow extra to pay for a home improvement or family vacation.
Real Wisdom #5: Invest in some serious soul searching before you borrow a bigger amount -- which could wipe out the home equity you're accrued over the years. Remember, your house is on the line! Home improvements can be good investments, but many can be done slowly, over time, with your own "sweat equity" -- rather than by eating into the equity you've worked hard to attain. And while a fabulous family vacation sounds awfully appealing, the great memories could quickly fade if times get tough and you're mired in debt.
Conventional Wisdom #6: Fold the upfront closing costs into your refinanced loan. Lenders are happy to do it.
Real Wisdom #6: Invest the time to think through what's really in your best interest. You can't count on the lender to do that. And remember, anytime a lender suggests that you "fold in" costs on an already big loan, you're likely to lose in two ways. First, you probably won't comparison shop or negotiate fees as hard if you're not paying them upfront, out of your pocket -- so you may pay more than is necessary in closing costs. Then you could get stuck paying interest on these high-priced fees for a long time, maybe as long as 30 years!
Conventional Wisdom #7: As long as you're refinancing, go for a 15-year term if you can swing the payments.
Real Wisdom #7: We're all for paying your mortgage off as quickly as possible. But just because you can swing the payments for a 15-year mortgage today, can you be sure your financial situation won't change in the years to come? I doubt it.
Take out a 30-year mortgage, and pay it off like it's a 15 year. If you do ever run into rocky times, you can slack off and just make the regular payments for a while, without worrying about getting behind on your mortgage.
Marc Eisenson's new book, Invest in Yourself: Six Secrets to a Rich Life (Wiley, 1998), which he wrote with Gerri Detweiler and Nancy Castleman, analyzes how we can spend our time, energy, and money for the greatest payoffs in life. The book is available in bookstores everywhere.
"Invest in Yourself won't tell you how to make a lot of money, but it will explain how you can live better on less than you think while saving money. The payoff is substantial: reduced stress, more security, a happier family, and a richer enjoyment of life. When the authors tell you to Invest in Yourself, they want you to recognize that you can use your knowledge and abilities to make a better life -- and do it on your own terms."
-- Paul S. Havemann, Vice President, HSH Associates
The nation's largest publisher of mortgage information
"Put life planning dream team to work for you.
When it comes to financial planning -- indeed life planning -- Marc Eisenson, Gerri Detweiler and Nancy Castleman are a dream team. ... Now they have combined energies and written a remarkable and inspiring book, Invest in Yourself (John Wiley & Sons, Inc, $22.95). The authors promise a lot -- the book's subtitle is "Six Secrets to a Rich Life" -- and readers will get their money's worth and more."
-- Jeanie Blake, The People Helper The New Orleans Times-Picayune