The Major Risks of Refinancing

When interest rates drop below what you are paying on your mortgage or when you have debts and expenses that need paying, refinancing your home can seem like a wonderful solution. While it is successful in many situations, there are some risks involved. Make yourself aware of all the ramifications before jumping into a major refinance.

Penalties and exit fees

Many mortgages contain clauses that charge a penalty for early repayment. When the financial institution granted your loan, it was with the understanding that the loan would produce profit for the bank, in the form of interest. Exit fees, transfer fees, and other penalties are put in place to discourage you from taking that source of income away from the bank. Paying multiple fees can add up quickly.

Closing costs

Any time you take out a mortgage, including the original mortgage or refinancing, there are costs involved with closing the deal. There are title fees, application fees, appraisal fees and other paperwork that can accumulate. You must weigh the amount of closing costs against what you are planning to save. It is smart to calculate how many months or years of reduced monthly payments it should take to break even.

The cost of adding more years to your loan

If you have 20 years left on your loan and you refinance it with a standard 30 year mortgage, you are adding 10 additional years of interest to your existing debt. Do the math to know for certain that this is a positive move. Increasing your cash flow a little now is often not worth owing thousands or tens of thousands more over the lifetime of your loan.

Refinancing your home sometimes makes good financial sense. Awareness of the possible pitfalls can put you in a stronger position to ascertain whether a refinance is the best course of action for you.