Many times, what we know about refinancing (and mortgages in general) comes from what our family, friends, and coworkers are continually telling us. While it's a good idea to seek advice from people you trust, be careful to avoid outdated information and, more importantly, information that is wrong altogether. The housing market is always changing, increasing the need to find the most accurate information as possible. Here are some of the most common misconceptions to look out for:
1. You should refinance if rates drop 2%
For one thing, you could end up paying more in fees and closing costs than you would have spent by sticking with your original loan. Some mortgage companies will offer to “fold in” the closing costs so you owe nothing up front, but keep in mind that you'll be paying interest on the folded amount during your loan term.
If you are already 10 or 20 years into your 30-year mortgage, refinancing to another 30-year loan will obviously only increase your costs. On the other hand, if you plan on being in your home for a long time and need more flexibility in your budget, then sometimes you don't even have to wait for a 2% drop in order to save money.
2. Refinancing always saves you money
The typical reason for refinancing is actually to lower your monthly payments, which involved stretching out your loan term. While this does save you money in your monthly budget, sometimes you can end up owing more in the long run.
3. You don't need to refinance if you just double up on your current payments
This can sometimes be a smart move, but only if you understand the conditions of your current loan. For instance, some loans carry a prepayment penalty, meaning you will be charged for paying off the loan faster. In this case, you would want to refinance to a shorter term and hopefully save a little extra money on interest in the process.
4. Refinancing to consolidate debt is always a good idea
While consolidating debt can make it easier by making one low monthly payment, it can also mean freeing up credit so you can rack up even more debt. Many consumers are looking for the simple way out by creating one big pile of debt. However, if you are not ready to change your lifestyle by backing off spending and focusing on eliminating current debt, you could end up with way more debt than you originally started with.
5. If you can afford it, a 15-year loan is always better
Before you refinance into a 15-year mortgage in hopes of saving money over the long run, remember that you can't always predict unexpected expenses in the future. For example, having a major medical emergency has been know to bankrupt savings accounts across America. So it might be smarter to take out a 30-year mortgage (making sure there are no prepayment penalties) and then pay it off in 15 years.