Should you Refinance?
Refinancing a mortgage is different from taking out a second mortgage or home equity loan in that when you refinance, the new mortgage takes the place of the old one instead of existing alongside the original. In other words, you still have only one monthly payment to make, rather than two. In both situations, your home is still pledged as collateral against a default on the loan.
During the first several years of the 21st century, refinancing got so common that you could hardly watch TV or listen to the radio for an hour without encountering at least one ad urging you to refinance your home. All of them promised quick, easy procedures, often with no closing costs. Many of them even allowed you to do it online without ever even speaking to a loan officer. Many homeowners refinanced their homes repeatedly, sometimes as frequently as every six months, in hopes of locking in ever-lower interest rates and cashing out their equity.
However, the process could not continue forever, particularly given that a lot of the equity being cashed out was not real growth in the value of the homes in question, but artificially inflated values that resulted from rampant speculation in the housing market. When the bubble burst, many homeowners were left not only owing far more than their homes were worth in the corrected market, but owing far more than they should've had they only let their equity build.
Obviously, refinancing isn't nearly so easy nowadays as it was five or ten years ago. Banks are in a credit crunch, so refinance deals are a lot harder to get than they were in the heyday of refinancing. Still, it's not impossible to refinance, if you have excellent credit and can find a bank that has money to lend.
However, you still want to be sure you're refinancing for the right reasons. Far too many of the people who got in trouble as a result of refinancing in the midst of the housing bubble did so because they were cashing out their equity in order to fund a lifestyle of unaffordable consumption. They treated their homes like ATM's, cashing out money to pay for expensive vacations abroad, fancy cars, big-screen TV's and the like, and had nothing to show for all of it when the crash came and their homes' values plummeted.
However, that should not be taken as a blanket condemnation of refinancing. There are in fact two categories of good reasons to refinance. The first is to lock in a better rate on your mortgage. For instance, you may have originally had to buy your home on rather bad terms. You didn't have very much saved to make a down payment, so you had to accept an ARM with a high interest rate, as well as PMI. Now, after several years of faithfully making payments, you've got enough equity to get a much lower fixed interest rate and no PMI. You don't actually take out any of the equity in your home, just get a better deal so that you aren't paying such a big house payment every month, and maybe can even start making some extra payments that will shorten the life of your new loan. In this case, refinancing is not only not foolish, but is actually a very prudent thing to do.
The second major type of good reason to refinance involves cashing out equity, but instead of using it to fund a lifestyle of consumption, you use it to improve the value of your home by making major repairs or remodeling. Alternatively, you may use it to help fund an advanced education for yourself that will increase your earning power. In both of these cases, you're spending the money on something that will last, and that may well actually pay for itself over the life of the loan. However, if you are undertaking this kind of refinance, you want to make sure that the expenditures you are planning will actually result in the returns, and that you aren't just rationalizing something you want to do. Obviously major structural improvements on a home such as a new roof will result in an increased value both in terms of its resale value and in terms of its livability for you. However, there are some remodeling projects that may be fun to contemplate, but really don't add that much value to the home, and may well add additional upkeep costs in the long term which run the risk of becoming a bleeding sore in your budget.
Whatever your reasons for wanting to refinance, you need to think about it carefully before you plunge in.
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