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Home Refinancing Pros and Cons

Apr 9, 2008
Home refinancing can be a very good financial strategy, especially when mortgage interest rates are low. This is easy to understand since a lower interest rate means a smaller monthly payment on a given mortgaged amount.

Still, before anyone decides to refinance, he should look at the pros and cons and, even more importantly, see if refinancing will work to his benefit in his particular case. This is because it is impossible to make a blanket statement as to rather refinancing is a good thing or not since everybody's situation is different.

In this article, we're going to look at the good and the bad points of refinancing. We will do so by looking at a case where a family did refinance and we will see how it worked out for them.

A refinance case study

Around 10 years ago, a family in the Northeast bought a modest home for $175,000. They made a down payment of 20%, which amounted to $35,000. This means they took a mortgage of $140,000 for 30 years and found a good interest rate for that time which was 7.5%.

This made their monthly payment, before taxes and homeowner's insurance was added on, $978.90. They had no trouble making their monthly payments on time. However, as families often due, over the past 10 years they accumulated credit card debt of $20,000.

The average interest rate on these cards was 22.9%. I know, it is ridiculous, but that is the way it is with credit cards. If they wanted to pay off these credit cards in full at this interest rate in 10 years time, they would have to make a monthly payment of $425.72. If instead, they decided they would just go on making the minimum payment each month, they would never pay off the cards.

As you know, credit card debt never goes away, it just keeps getting higher. So, now let's move ahead to early 2008 when this family sees interest rates are down to 5.5%. Better yet, they find houses in neighborhoods similar to theirs selling for $250,000 and up. So, they look into refinancing and here's what they find.

They would easily qualify for a mortgage of $200,000 since their home would appraise at more than $240,000 with no problem. This means they would be borrowing an amount less than 80% of the value of the property. Also, since they had a decent credit history, they would qualify for the preferred rate of 5.5%. This is an important point because people with poor credit will pay higher interest rates.

The new mortgage

The family decides to take a 30-year mortgage at 5.5% on $200,000 and their monthly payment becomes $1,135.58. At closing, they receive a check for $52,000. Here's how that worked.

After paying on their old mortgage for 10 years, they had paid off $19,000 principal. This means they still owed $121,000 on the house. This of course, was paid from the $200,000. Also, their mortgage holder insisted they pay off their credit cards at closing. This is normal. So, that was another $20,000 taken out of the $200,000.

On top of that, they had closing costs, which included points of $7,000. So, they had used $121,000, $7,000 and $20,000, which left them with $52,000 and they were credit card debt free.

Here's how the monthly payment worked out. With their old mortgage, they were paying $978.90 plus an additional $425 on the credit cards. So, even though their mortgage payment is now $160 a month higher, since they are no longer paying credit card payments, their monthly commitment is about $265 less.

How it worked out for the family

This is a refinance that worked out very well. The down side is, they will be paying a mortgage for an additional 10 years because they already had paid for 10 years and now they are starting over with a 30-year mortgage.

With their previous mortgage, while they were paying $19,000 toward there principal, they paid approximately $98,000 in interest charges. So, altogether, they paid $117,458 to this mortgage company! Additionally, by the time they pay their new mortgage, if they use the full 30 years, they will have paid them $408,808.80. So altogether, they will have paid $525,000 on a house they purchased for $175,000.

To pile on a little more bad news, they probably paid about $5,000 or so in closing costs on their first mortgage and $7,000 on their new one. So, that is $12,000 out the window, so to speak.

Still, a refinance can be helpful when it let's you replace high interest credit card debt with low interest mortgage debt. Also, it may help finance college tuition or even better get you into a situation where you can budget your money when before the refinance, the numbers just didn't work.

When looked at this way, a refinance can be a golden opportunity to start your financial life anew. The problem is, oftentimes people will not carry out their new budget and even worse they will start building up high interest credit card debt once again.

Make sure you don't fall into this trap. If you can do a refinance that works out for you, don't blow it. This could be your last chance. In a short time, we will be electing a new president and some of the campaigner's promised agendas sound like something out of a manual on how to create hyperinflation! It would be smart to get a low, fixed-interest rate mortgage now, if that is at all possible.
About the Author
Ed Lathrop is a successful Real Estate investor. He has developed EzCalculator, a Mortgage Calculator that shows you how to save $100,000 on your mortgage. Come visit this free site at Free Financial Calculator. Also, find out how to get your amortization schedule and use it to save big money at: Amortization Schedules Free. These sites are not owned by any lender, so no one will harass you for visiting!
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