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When Refinancing To A Higher Rate Make Perfect Sense
On the surface, it will look ridiculous to refinance a 20-year fixed rate mortgage at 5% to a 20-year fixed rate mortgage at 6%.
All you are doing is getting a new similar loan at a higher rate.
But there are certain circumstances where do that is an obvious thing to do.
Better alternative investments
The first reason why refinancing to a higher rate can make good sense is when you have identified an investment that will give you a return much higher than the interest of your home loan.
In this case, you will be taking up a new loan to replace the existing one and take on more debt in the form of a term loan or credit line (HELOC).
For example, your outstanding debt is $500,000, and you are able to take on a new loan at 80% loan to value of $1,000,000. This works out to $800,000.
You will then use $500,000 of that $800,000 to repay the first mortgage, and use the balance of $300,000 for your investments.
Bear in mind that making a move like this must mean that the investment returns exceed the cost of your loan. It wouldn’t make sense otherwise.
The second most obvious reason how that can be so is debt consolidation.
Credit card debt is among those credit facilities that charges an arm and a leg on interest.
It is not that difficult to find mortgage rates sensationally lower than those of credit cards.
On top of that, mortgage interest are tax-deductible if your debt does not exceed the home value.
No wonder more and more financial advisors are advising their clients to consolidate their liabilities by refinancing their homes.
The main disadvantage of going ahead with a move like this is that previously unsecured debt will now become debt secured by your home.
Some people are just not comfortable with that. They see it as a step back for their financial status.
And if for some reason you are to default on credit card debt, you can stop paying and that is that. You still have your home.
But by consolidating all those debts into your home, the threat of foreclosure when you do not pay can leave you sleepless at night.
Another disadvantage of taking on a second mortgage is that it can become difficult in future to refinance your first mortgage as the second lender will now have to agree to subordinate their mortgage.
If your lender is one who is in a bad mood all the time, it could be tough to convince them to agree to your request.
And if they have no problem with it, you will usually be charged a fee for the administrative work.
Then if you have been paying mortgage insurance, signing up for a second mortgage will extend the period which you have to pay for it.
To terminate the insurance policy, your balance for the first mortgage has to be repaid to a lower level when a second mortgage comes into the picture.
Now if your new total debt exceeds the property value, you will need to fork out considerable cash to pay off the debt should you need to sell the home.
Because when a home is sold, you can expect that you must use those funds to repay what you have borrowed for the house.
So if the house is now worth $500,000 and your outstanding loan is $550,000, this means that you have to top up the $50,000 difference with your own cash.
That can hurt.
There are many reasons why you might have to relocate. They are usually reasons connected with work or family. And those 2 things are hardly something you have 100% control over.
Why not a home equity loan?
One of the advantages of equity loans that are commonly played up be brokers and bankers is to use it for debt consolidation.
On the surface, it can look abundantly clear that refinancing the home loan is a good calculated choice in managing your finances.
This is because interest rates on a second mortgage will usually be considerably lower than the rates you are being charged on your credit cards.
With tax deductables, it becomes an even more tempting thing to do.
Consolidation your debts this way however, also has it’s disadvantages.
The first is that you might find it difficult to refinance your first mortgage if a good opportunity comes up in future.
This is because your loan that is tied with the equity loan had effectively become you first mortgage.
You might still be within a lock in period or the lender might not be willing to subordinate to the new loan you are considering.
Mortgage insurance also comes into play.
As it was first tied up to your first loan, you will now have to sign up for a new one. And since you are taking up a bigger total quantum this time, you will probably have to pay a higher premium and also for a longer time period as well.
The biggest pitfall is a mental one.
If you are a person who have already displayed an ability to chalk up overdue balances on your credit cards, what makes you think anything will change once you get your hands on more money this time.
Remember that when you chalk up huge bills, you are not the only one who suffers. Your family is affected from either your lower cash flow or they have to pay the bills for you.
If anything, the feeling of being credit free again might tempt you to go back into debt by overspending and buying things you do not need.
Take retail therapy for example.
When we visit the mall, we often spend money to buy luxury items that we never use anyway.
It’s the great feeling of buying expensive items that make us feel good about yourself.
Having so much extra cash on hand will be like carrying a loaded credit gun around town. Ever eager to fire.
It could be surprising to you that we are advising against refinancing.
But facts are facts and we are just giving our opinion. You are surely mature enough to make your own decision.
Whether you are going to do it or not will probably not be swayed anyway by just an opinionated article.