Home refinancing is one of the most important decisions you may make. You should think of your home refinance options thoroughly before you settle on your decision. Many people consider refinancing their home on what is left on the mortgage, and they do so because they want to lower the interest rate on the house. Other people are thinking about refinancing their home because they want to take extra money out from the value of the house. The main reason people refinance and take some money out of the equity is because they want to spend the money on home improvements, cars, boats, college, real estate, business ventures and many more.
I am here to help people better understand what actually happens in a mortgage or a home refinance. A home refinance can also be called an equity line of credit. I'll go over a broad example of what happens when you get a home refinance to pull money out in order to buy something. Keep reading for good information.
It is very smart if you are refinancing your house to get a lower interest rate. If you are doing a home refinance to take money out from your home's equity to spend on something like a car, or a depreciable asset you might want to think the thought through before you decide.
Doing a home refinance can be a an excellent idea, only if you know what you are doing. You should learn what all the terms and conditions are in a mortgage contract before you sign anything. Another thing to keep in mind is the actual total interest you will pay on your refinanced mortgage if you take money out to buy a car, boat or the like.
Case in point:
The increase of your monthly mortgage payment will be tempting if you look at it thinking your payment won't go up a lot if you use the money to buy a car. Say for instance you are going to buy a car with money you pull out of your home's equity. Your current outstanding principal for the mortgage is $300,000, and your interest rate is 5%. The current payment for the mortgage is $1,600. Your home is valued at $500,000, and you want to take out $30,000 to buy a car. Your new mortgage payment will be $1,770, which is only $170 more than your old payment. Now, this does not sound like a bad deal does it?
Lets go over what exactly this includes when you buy a car using your home's equity. We took out $30,000 from the home's equity to pay for a car. The mortgage was refinanced at $330,000 with a 5% interest rate. Over 30 years of paying your mortgage, you would paid a total of $28,000 just from interest alone. That means that the car actually costs $58,000, which is almost double of what the value is. During this time, in most cases, the car's value has depreciated to nearly zero or it's unlikely you would still own it.
Some people might decide to change their mind when they discover this fact. Although that is a scary number when you see it written out, you can still use your home's equity and not pay all that interest. In order to avoid the interest, you would need to make extra payments on your mortgage. Doing so will decrease the amount of principal on your refinanced mortgage loan. It also decreases the time your home loan will be paid off.
Another thing people run into when they are talking with a loan officer, is the loan officer will suggest consolidating all of your bills into your mortgage. Now, what is the "good" thing about refinancing your home mortgage and consolidating all of your bills like credit cards with it? Well, your monthly payment for all your bills will go down. You will only have to pay one bill instead of 3, 5, or however different many bills you have. Now lets think of the horrible downside.
When you consolidate all of your bills onto your mortgage, you are now paying those bills over 30 years. Although you are paying a 5% interest rate, the amount of interest you have paid in 30 years amounts to piles of cash. You can refer to the example of pulling out equity money to buy that car. Not only do you pay the interest on that, but you are also paying origination fees and all the other fees that are associated with a home refinance.
Even though I have said the negative points of refinancing to purchase things with your home's equity, it does not hurt to think of all the home refinance options you have. You could use the money from your home's equity to invest in a business or real estate. If planned correctly, you can use this money to earn more money and offset the interest you will pay. Maybe if your business idea turns out well, it might even start making the mortgage payments for you.
There are a lot of reasons a person might decide to look at their home refinance options. Some people might refinance the mortgage on their house to lower the interest rate, which in turn lowers the payment. Other people will refinance their house to take money out from the equity they have. There is a lot of different types of mortgages, and you should know how each one you are considering works. One misunderstanding or important fact that slips past you can cost you tens of thousands of dollars in the long term.
There is a Bean Theory of Finance. Put in one bean, get out two. If refinancing your home saves you a bean that you would otherwise have to pay in bills, save that bean and use it to earn two beans, then four beans, then eight beans and so forth rather than spend it on something that only has 1/2 a bean or less in value later and hasn't produced you any beans.
By: Tom Maneval
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