This will end up in the toolbox, but because only yesterday I posted an exciting post on the reasons why you should consider NOT refinancing, today I think it’s appropriate to post some of the concerns a good advisor might have when a client is considering changing a home loan.
There are so, so many variables to consider—to cliché this article as quickly as possible—your head will spin.
Let’s forget the smart-talk and just jump into the list:
1) Cash flow. This is the primary hook mortgage companies use to secure your signature on the bottom line. Like a fish to the worm, all a lender has to say is that “you’re gonna save $300 per month!” and we’re all lining up drooling for debt.
(Apparently the only offer credit card companies need to bait the hook is a free NASCAR blanket, but that’s another story.)
Comparing cash flow isn’t as important as knowing how you’re going to use your new free cash each month. If you plan to use the funds for a boat down payment, you may wish to reconsider. However, if you can set up an automatic payment to alleviate some other debt or save into your child’s college fund, I’m on board.
Final analysis: Just like you shouldn’t eat hamburgers every day just because they tastes good (lesson learned!), you shouldn’t choose to refinance based on cash flow alone.
2) Length of loan. If you’re close to paying off your mortgage, why would you sign up to start over again? I’ve seen people refinance to a lower rate and smaller payments, only to be in debt for 27 years longer than necessary. If you’re craving cash flow, are there other areas of your life that can be cut to avoid a mortgage refinance.
Final analysis: Compare terms before signing on the dotted line. Dying with debt isn’t as fun as your weird brother-in-law makes it sound.
3) Know thyself. Mortgages aren’t always about math and the “logical move.” I’ve met some pretty broke professors during my time advising families. Instead, often taking on new debt is about knowing yourself. Can you handle flexibility? Will you pay extra Here are some options:
– Use a portion of your savings to shorten the loan terms. Ask the lender if they’ll complete a rate-and-term mortgage, where your payment drops but the length of the loan stays the same. If not, ask what shorter terms are available. You may be surprised that the lender will offer you a lower rate on shorter-term loans.
– Throw your savings toward larger payments to pay the loan down early. Personally, I like this option. But once again, know theyself. This would have been the worst option for many of my clients.
Here’s why I like the last option: things happen. When you’re in financial trouble, I like the flexibility of being able to stop paying extra on the mortgage. I have a built-in safety net when times are tough…and over the next several years, who knows what’s going to happen?
I also trust myself to pay extra on the loan. Can you say the same? If not, lock yourself in on a shorter term to force yourself to pay more. You’ll be thankful you did.
Final analysis: What is your money personality? Are you desperately seeking boundaries or do you prefer long walks in the rain hand-in-hand with flexibility?
4) Terms. Mortgages, friends, aren’t free. I know. Before you swoon you may wish to sit down. But before you flip out and rush the refinance train, let’s compare costs with benefits. Does it make sense to save a few bucks if you’re going to spend much of your savings in expenses.
Here’s an easy, worthwhile math problem. If you’re going to save $200 per month and the refinance expenses are $2,400, it’s going to take a whopping two years before you realize a dime of cash flow savings. Additionally, you won’t wrap your arms around any interest rate savings until much later in the mortgage. For more on that topic, read this post.
There are no-point, no-cost mortgages available, but they aren’t free either. When a mortgage company agrees to let you off the hook on fees, they’ll recoup the money they lose by jacking up your interest rate a little. Many advisors prefer this again—although they know it’s a higher rate–for flexibility reasons. For me, it always depended on the client and how high the fees would have been if we’d just paid them.
In this market, I kind of like paying fees up-front. Knowing that historically rates haven’t bumped this low often, there’s a great chance I’ll never refinance again. By getting the fees out of the way now and maybe even paying points to get them even lower, I can save a ton of money now.
Final analysis: Fees are a reality. Decide where you’d rather get hit instead of letting the bank just smack you!
5) Total debt scenario. Many families separate their credit card debt, car payment and home loan from each other. My brother doesn’t like the different foods on his plate to touch. I’ve never understood either of these.
Think of yourself as a company. All that your board of directors is worried about is the bottom line. Create a total debt repayment strategy. Now you’ll analyze your home debt more wisely:
– Can I take care of some credit card balances while refinancing? Note: remember rule #3 above? If you’re just going to keep using the credit card, all you’re doing is taking short-term consumer debt and turning it into long-term debt against your house. If you can’t control your credit card spending you don’t want to lose your home.
– What is the refinanced loan going to do to my debt picture long term? Will I now have a mortgage in retirement? While my kids are in college? Are there ways to restructure your debt to avoid these upcoming cash flow crunches?
Final analysis: You read the entire map when headed on vacation, not just the next few miles. Include all the variables in your analysis and view your family financial picture as a business to make better decisions.
One area some may be surprised I didn’t include with these five factors. Don’t try to guess the future direction of interest rates. That’s betting, which is a losing game. Evaluate the current opportunity and whether changing course will help your family or not. Don’t get too interested in your refinance market horoscope.
Joe
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