This is article four of Part Two of the “Conquering Debt Series.” Read Part One here.
Are you thinking about refinancing your home loan? People refinance their home loans for a variety of reasons. There are situations in which refinancing makes sense, but there are also times when refinancing is a bad idea.
In this article, I’m going to present twelve rules and warning signs to consider if you are thinking about refinancing your current mortgage or are thinking about taking out a second mortgage on your home.
If you are already in the middle of the refinancing process, it’s important to remember that you can always back out of a refinancing deal before the papers are signed.
You should never feel embarrassed to walk away from a lousy loan even if you are being pressured. There are some situations where lenders will threaten penalties or legal action if you do not sign papers that have already been prepared. You have no responsibility to pay if there are no binding agreements, and there is no agreement until you sign the papers.
WHEN IN DOUBT, DO NOT REFINANCE OR CONSOLIDATE DEBTS
Refinancing deals almost always come with significant costs. These costs can vary according to the interest rate, credit score, lender, and loan amount. Some of the fees you can expect when refinancing a home loan include credit fees, appraisal fees, points (an optional expense to lower the interest rate over the life of the loan), insurance and taxes, escrow and title fees, and lender fees.
If you are already facing financial difficulty, these costs will usually just make matters worse in the long term.
DO NO LET DEBT COLLECTORS PRESSURE YOU INTO REFINANCING
If you are facing hard times and are dealing with collection efforts, debt collectors may try to scare you into refinancing because they have no other way to get their money.
If you feel like you are being pressured, you can always specify how and when debt collectors can contact you, and that they cease communication altogether.
They are not allowed to mislead you about who they are, how much money you owe or the legal repercussions of not paying your debt. You also have the right to dispute the debt. If you choose to challenge the debt in question, the collector cannot ask for payment until the dispute is settled.
NEVER (OR ALMOST NEVER) REFINANCE UNSECURED DEBT INTO SECURED DEBT
Most debts are “unsecured.” This means that a home, car, or other property is not collateral for the loan. Some examples of unsecured debt are hospital or doctor bills, lawyer’s bills, and most credit card debt.
When you trade in unsecured debt for a mortgage loan, you face the loss of your home if you continue to have financial problems. You should never refinance unsecured debt (most credit card debt), into secured debt even if this allows you to lower the interest rate you are paying.
The interest rate on the mortgage loan might be lower, but these are usually at least twenty or, more commonly, thirty-year loans. If you are paying at a lower rate for that extended period of time, it will almost always cost you more than a higher rate on a short-term loan. This is the result of adding your credit card debt to a mortgage loan.
DO NOT TURN YOUR CAR LOAN INTO A SECOND MORTGAGE UNLESS YOU WOULD RATHER LOSE YOU HOME THAN YOUR CAR
If you are in danger of losing your car, you may be tempted to pay off your car loan by taking out a second mortgage on your home. Doing it this way, you save your car, but you put your home in danger.
Although repossession is terrible, foreclosure is worse. This type of refinancing adds the car loan into the mortgage loan, turning a five-year loan into a thirty-year mortgage. This will significantly increase the amount of interest you pay.
DO NOT REFINANCE LOW-INTEREST DEBTS WITH HIGHER-INTEREST LOANS
When refinancing your home loan, you should always evaluate the interest rate on the new loan and look for a lower rate than the old debts. You already paid certain fees in the old loan, and you need to make sure that a new lower rate is actually lower after BOTH the old and new fees are accounted for.
Keep in mind, the APR (Annual Percentage Rate) of the new loan must be lower than the interest rate stated in the note of the old loan, or you will be losing money. The APR is merely the cost of credit as a yearly rate. It is often higher than the interest rate on your loan note because the APR takes into account both the interest rate plus certain fees that the lenders add to the cost of the loan.
You also need to consider other fees, charges, and expenses that are not considered interest. If only consider interest, you may trade a loan that looks cheaper for one that’s actually more expensive.
DO NOT INCLUDE YOUR LONG-TERM FIRST MORTGAGE IN A REFINANCING PACKAGE
Whatever you do, do not let potential lenders pay off your first mortgage and give you a new mortgage equal to the first mortgage plus the new loan amount.
The only exception is if the new mortgage is for the equivalent length of time and the APR is significantly lower than the interest rate on the old first mortgage (to offset prepayment penalties, fees, and charges).
WATCH OUT FOR VARIABLE RATES
Variable-rate refinancing loans can be sneaky. In any variable-rate transaction, the monthly payment can increase drastically when you can least afford it.
Some loans have super low-interest rates, which results in low mortgage payments, during the first months or years, called “teaser rates.” Just beware that your interest rate and payments can increase with variable interest rates.
DO NOT REFINANCE LOANS WHEN YOU HAVE VALID LEGAL REASONS NOT TO PAY DEBT
If you are refinancing because you are dealing with debt issues, see if you have a legal defense for repayment of debt before resorting to home loan refinancing.
If you refinance with a new lender, the defense may not be available against the new lender. If you decide you need legal help to determine if you have a defense, you should always get that help BEFORE entering the refinancing deal.
TAX ADVANTAGES FROM A DEBT CONSOLIDATION LOAN
There are lenders offering bad refinancing deals who talk about the benefit of the tax deductibility of mortgage interest. Make sure you understand how your own personal tax situation will be affected.
For example, if you do not itemize deductions, the tax deductibility of mortgage interest is worthless.
AVOID REFINANCING DEALS THAT ARE SCAMS
Whenever you are dealing with refinancing, there’s potential for hidden costs, fees, and other unfair loan terms. If you are having doubts, make sure to get help in reviewing the loan papers BEFORE you sign ANYTHING. You can always walk away from a bad deal at the last minute.
Any lender that is unwilling to let you get outside help before you sign the loan documents should not be trusted.
Never let a contractor of salesperson arrange financing for you and be wary of mortgage brokers.
Unfortunately, some brokers find you refinancing deals which involve big commissions for them rather than good loan terms for you.
IF YOUR HOME IS COLLATERAL IN A REFINANCING DEAL, YOU HAVE THREE DAYS TO CANCEL
In most cases, if you give the lender a mortgage, federal law gives you the right to cancel for any reason for three business days from the date you sign the papers (this rule does not apply to purchase money mortgages).
If you want to cancel, make sure you so in writing before the deadline. The lender is required to give you a form for this purpose. You can, but don’t have to, use the cancellation form provided by the lender. You may cancel the loan by sending a signed, dated letter indicating your desire to cancel the refinancing. Always keep a copy of any written correspondence and mail it by registered or certified mail.
IF IT SEEMS TOO GOOD TO BE TRUE, IT’S PROBABLY NOT TRUE
One of the most common goals for refinancing your home loan is to lower your monthly payment. Everything might seem to be good to be true, but in reality, your costs are higher in the long run.
Before you make any decision, make sure you receive a Loan Estimate so that you can easily do a side-by-side comparison of mortgage costs. Once you are done shopping around and you have chosen a lender, you will receive a Closing Disclosure outlining all of the charges that will be assessed at signing three days before finalizing your loan. Make sure you understand all of the information and don’t be afraid to ask questions!