Personal Finance > Your Home
Red flags on refinancing
Lowering your monthly mortgage payments may be tempting, but doing it can cost you big.
September 6, 2002: 4:09 PM EDT
By Jeanne Sahadi, CNN/Money Staff Writer

(This article, originally published in March, was updated Sept. 6.)

NEW YORK (CNN/Money) -- Another week, another record low for mortgage rates.

The persistence of historic lows on home lending rates has led to several waves of refinancing that have left mortgage lenders scrambling to keep up with demand and turned some homeowners into refi junkies, who salivate at the prospect of lowering their monthly payments yet again.

With the 30-year mortgage averaging 6.15 percent and the 15-year fixed-rate mortgage averaging 5.56 percent for the week ending Sept. 6, about half of all homeowners still might benefit from a refi at current rates if they can lock in those rates today, said Mark Zandi, chief economist at If mortgage rates creep up somewhat in the coming weeks, with the 30-year fixed hitting 6.25 percent, then only one in three homeowners might benefit from a refi.

But even if you get a better rate, a refi isn't always an unqualified good. In fact, many factors can make a refi a costly decision in the long run, especially if you're focused on lower monthly payments or drawing equity out of your home to pay off debt.

If you're thinking of refinancing your mortgage, consider the downsides before making your move:

So what if you have a higher-than-average interest rate? A refi might be more work than it's worth in the current rate environment if you already have a mortgage under 7.25 percent, said Keith Gumbinger, vice president of mortgage tracker HSH Associates. Should rates rise even a little in the next few weeks, the difference between your current rate and your new rate isn't likely to be significant, and whatever savings you achieve might be far less impressive once you factor in closing costs. Another reason to skip a refi is if you plan to sell your house within three years. That's because after forking over closing costs -- which easily can amount to a few thousand dollars -- it can take several years for your savings to offset your out-of-pocket costs. Sure, you could arrange for a no-fee refi, but in exchange you'll end up paying a slightly higher interest rate. Either way, Gumbinger said, "It's going to be difficult to do better than a wash."

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The longer you play, the more you pay. If your goal in refinancing is to save money over the long run and you plan to live in your home for 25 years or more, don't fall into the trap of accepting a new 30-year term, even though doing so may reduce your monthly payments. In other words, if you already have owned your home for five years, refinancing to a 30-year term would effectively stretch your mortgage out over 35 years, costing you an extra five years of interest payments. Generally speaking, unless you refi to a significantly lower interest rate -- at least 1.5 percentage points less -- and unless you're planning to sell the house well before your new mortgage is paid, it's likely you'll end up paying more for your home than if you had kept your existing mortgage, Gumbinger said.

Cash isn't always king. A cash-out refi may seem attractive if you're strapped for cash and your house has appreciated in value. Cash-outs let you convert your home equity to money in your pocket. Typically, you can do a cash-out refi for up to 80 percent of your home's current value. Say you bought your house for $200,000 using a $160,000 mortgage. Now your home is worth $250,000. You can do a cash-out for up to $200,000 (80 percent of the $250,000). After paying off the remaining principal on your existing mortgage as well as any closing costs for the refi, you can pocket the difference. Be aware, however, that often this means you'll take out a larger mortgage than your original one and you reduce the remaining equity in your home.

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If you bought at the top of the market and housing prices fall, you also run a higher risk of owing the bank money when you sell. Housing prices nationally have appreciated every year since 1968, but areas of the country do experience corrections from time to time, said Walter Moloney, a spokesman for the National Association of Realtors. If you get caught in the middle of one, you might end up having to pay the bank the difference between your sale price and what is still owed on your mortgage.

ARMs can be dangerous. More tempting still for those in a budget pinch is a cash-out refi to a short-term adjustable rate mortgage (ARM), which offers some of the lowest monthly payments of all. At least initially. That's because they offer very low introductory rates for the first few months, and then adjust every month after that (and in today's low rate environment, chances are good the adjustments will be upward). If you do choose this option, read the fine print carefully. Beware in particular of punitive provisions such as prepayment penalties or fees that are triggered if you refinance again within a certain number of years, Gumbinger advised. In these situations, your rate may be adjustable, but you lock yourself into what can become a very pricey loan.

Be careful about trading your security to pay off credit cards. Refinancing your home to pay off unsecured debt, such as credit cards, is usually unwise if you have a spending problem. That's because a home is secured debt. If you fail to pay your mortgage, you risk foreclosure. It's particularly a problem in a cash-out refi because you reduce the equity in your home, thereby removing one of your best cushions against a potential financial downturn in your life, Gumbinger said. And even if a refi makes your monthly payments more affordable today, should you have financial problems down the road, you may find yourself scrambling to meet your housing payments.

A better solution to paying off chronic credit card debt may be to consolidate your debt onto a lower rate credit card and to seek debt counseling. For help in the basics of debt management, read Money 101: Controlling Debt.  Top of page

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