People overwhelmed with debt often consider refinancing as a suitable option for paying off the existing debt and avoiding the embarrassment of payment default. Refinancing involves borrowing to pay off the current debt. The new loan is usually of the same size as the current loan. While refinancing, you would use the same collateral as used for securing your earlier loan.

However, refinancing has its share of pros and cons. Although it can save your house from foreclosure, it is a risky option that can worsen your financial problems in the future. Hence, before moving ahead with refinancing procedure, know the dos and don’ts about refinancing, and opt for refinancing only if you believe that its benefits will outweigh its risk.

Dos And Don’t About Refinancing

Avoid Refinancing If The Break-Even Period Is Too Long

Refinancing might not be a cost effective method of paying off your loans, if the break-even period of mortgage refinancing is too long. The number of months taken to recover your cost of refinancing is known as the break-even period. It might not be easy to calculate the exact break-even period. To predict the probable break-even period you should estimate the closing costs of the new loan, which could be calculated only if you can correctly forecast the future interest rate on the loan.

Check The Long-Term Costs Of Refinancing

Reduction in the monthly payment is the major benefit of refinancing. However, if the cost of refinancing rises in the future, you might find yourself in a financial mess in the long-term. After paying a small part of the principal and a large amount of interest on a 30-year mortgage loan for several years, if you discover that you can’t meet your monthly payment obligations, you might choose mortgage refinancing at a lower interest rate to close your current loan.

Although your monthly payments would drop owing to the lower interest rate, you must pay almost the same amount of principal as your earlier loan. Overall, you will end paying up more. The current lower payment does not guarantee that the cost will not rise in the long run. Moreover, refinancing would force you to remain in debt for a longer period.

Avoid Replacing Low Interest Loans With High Interest Debts

Mortgage refinancing is beneficial only if the interest rate on the new loan or the refinance rate is lower than the interest rate on the existing loan. Refinancing could be wise decision if the refinance rate is at least one percentage point below the prevailing interest rate on your existing debt. However, mortgage rate is not the only criterion for determining the cost effectiveness of refinancing. You should also compare the annual percentage rate or APR on the new loan with than on the current debt.

APR comprises of the mortgage rate and the closing costs. If the mortgage cost on your new loan is lower or equal to the mortgage cost on your current debt, but if the APR on the new loan is higher than that on the new loan, it means that the closing cost of refinancing is higher. You can only compare the APR between identical loans.

Do Not Use Secured Debt For Refinancing Unsecured Debt

Avoid mortgage refinancing to pay off an unsecured debt. Unsecured debts are the loans that have been offered without collateral. Your credit card and medical bills are the common types of unsecured debts. If you fail to clear your credit card bills, the debt collector might pressurize you to accept a mortgage refinancing to pay your dues. Despite the temptation of a lower interest rate, it is extremely unwise to choose secured debt for refinancing your current unsecured debt.

If you fail to pay your credit card bills, the bank or financial institution that issued the credit card would move court and seek for wage garnishment or non-wage garnishment that would freeze your bank account. But if you use mortgage refinancing to pay your credit card bills, you would lose your assets if you fail to clear the new debt.

Avoid Refinancing Regularly With The Same Lender

Photo Credit: Langwithdevelopments.co.uk

Often you would be tempted to obtain a refinance loan from your current lender to clear your existing debt. From the point of view of your current lender, refinancing is an inexpensive method of issuing a new loan. Your current lender knows everything about your mortgaged property. Therefore, property appraisal and title searches are not required when your current lender gives a new loan. Your lender would encourage you to opt for repeated mortgage refinance by slightly reducing the interest rate on the new loans.

If you ignore the high hidden cost involved in regular refinancing, your financial difficulties would aggravate in the long run and your lender’s profit will keep on multiplying. If other lenders are offering mortgage loans at a lower interest rate, you can obtain a new loan from a new lender. If you want to stick to your current lender, instead of opting for loan refinance, you can ask your creditor to lower your loan payments although it might attract higher interest rate, higher closing costs and prepayment penalties.

Check The Credentials Of The Lender

Fraud refinancing companies are always on the prowl. They are always trying to deceive debtors by luring them to take new loans on terms that are too good to be true. It is advisable to check the credentials of a lender with the apex banking institution and banking commission. Before doing business with a creditor, you can contact the consumer complaint hotline to know whether other consumers have filed complaints against the lender. Be careful of mortgage brokers.

Tempted by huge commissions, these brokers might fool you into accepting a bad deal. Also, be aware of salespersons that would come to your house with loan refinance schemes. Before signing a deal, if you are in doubt, ask a finance expert you trust to review the loan. To avoid frauds and prevent foreclosure you can consult non-profit finance counseling agencies. Even after signing the mortgage refinance paper, you can cancel the deals within three days after signing the papers.