Refinancing Positives and Negatives | Real Estate

If mortgage rates have dropped below the rate you are paying for your existing mortgage, refinancing may be an attractive option for you.  However, depending on your own individual circumstances and on how you refinance, there are both positives and negatives to consider.  Generally speaking, people refinance for two reasons.  The first is to lower their monthly payment or reduce the life of the mortgage by applying for a rate of interest lower than their current rate.  The second is to use the equity in their homes for other purposes.

To help you evaluate these pros and cons it is highly desirable that you secure the services of a knowledgeable and trustworthy loan office or mortgage broker.  Since they stand to make a fair amount of money from your potential refinancing transaction, not all will advise you that there is a threshold rate, below which it might make no sense to refinance.

That rate is usually one and one half percentage points below your current mortgage.  There are document transfer fees, taxes, and a host of other sometimes hidden charges that could actually make refinancing your property a winning proposition for everyone but you.  If the new rate you might be able to get is lower, refinancing is something to explore.

The positives of refinancing to use equity for other purposes can be significant and if done properly could benefit your financial situation greatly.  The negatives, on the other hand, could destroy you.   Strangely enough, the negatives are generally a result of taking a positive aspect of refinancing and extending it to the point of danger.  Let’s look at some of these positive features and how they can explode in the face on unwary homeowners.

To illustrate let’s assume the balance of your existing mortgage is $80,000 while your house is now worth $200,000, leaving you with 120,000 in equity in your home.   Even if the new rate is slightly higher than your existing rate many homeowners choose to refinance, taking out a loan of $120,000.  With sufficient income to make the higher monthly payment, this might make good sense as it leaves you with a $40,000 pot of money you can use to buy other real estate or invest in the share market or in bonds or government securities.

The positives continue to build as long as home prices continue to rise, increasing your equity to the point where you might be able to refinance again.  Now the negatives begin to creep in.  You have undoubtedly heard of the complete collapse of the housing market in the United States.  Many who failed to consider the negatives of refinancing have been ruined while countless others find themselves staring into a financial abyss because of their refinancing.

In the illustration we used above, the homeowner who took out a new loan of $120,000 was left with $80,000 in equity still in the home after the original mortgage was paid off.  This cushion provides some breathing room in the event of a decline in home prices, leaving the homeowner with a home worth less than the $200,000 value at the time of the refinance.  In America, many people took every dime of equity they could out of their homes again and again, every few years.  Indeed some financial experts were advising people to do this to make the most out of “other people’s money”, using the leverage for other investment purposes.  When housing prices collapsed and other forms of investment soon followed, thousands were ruined.