Lesson Two: Consider the pros and cons of a refinance
Can we improve our current financial situation by studying the past? Let’s take a look.
When the Great Depression struck, many US homeowners were unable to meet their mortgage payments. By 1932, the average national income had fallen off the cliff, down to below 50 percent of what it had been in 1929. Upon signing the Federal Home Loan Bank Act in July 1932, President Herbert Hoover stated: "The purpose of the system is both to meet the present emergency and to build up homeownership on more favorable terms than exist today. The immediate credit situation has for the time being in many parts of the country restricted the activities of building and loan associations, savings banks, and other institutions making loans for home purposes, in such fashion that they are not only unable to extend credit for the acquirement of new homes, but in thousands of instances they have been unable to renew existing mortgages with resultant foreclosures and great hardships.”
“Hardship” was an understatement, in fact, at the time Hoover was speaking, more than one million homeowners were facing foreclosure. In 1933 President Roosevelt signed the Homeowners Refinancing Act, enabling people to adjust the terms of their loans. This meant they could reduce their monthly costs and hopefully be able to keep their homes.
Right now, mortgage rates are incredibly low. Whether or not the pandemic has affected your finances, and even if your loan is only a few years old, you may be able to benefit from refinancing. As it did during the Great Depression, refinancing can lower your monthly mortgage payment, and a lower payment might be the difference between being able to keep your house and having to give it up.
Keep in mind that when you refinance, you are paying off your old mortgage and creating a new one. Lenders will be looking to determine if you qualify for a new mortgage just as they did for the original one. If your credit score has gone either up or down, for example, the interest rate you are offered will be affected. Housing prices may have declined in your area, making your home worth less than it was originally. There are other factors that affect your eligibility for refinancing and the terms you can expect. If you qualify, you still need to determine if the terms of the new mortgage, such as a lower interest rate, a different number of years for paying off the mortgage or changing the type of mortgage, are actually to your benefit. Do they further your financial goals in the short term? In the long term? And you also need to factor in costs associated with the refinancing, including any prepayment penalties on your current mortgage and how close you are to paying off your present mortgage.
All this can feel like a complicated balancing act. And in many ways it is. Even the goals for refinancing vary from family to family. Some may desperately need to lower the monthly mortgage payment in order to meet other essential expenses. Others may simply want to take advantage of the current low mortgage rates. Still, others may want to get cash out of the equity that has built up in their home to tide them over the current crisis.
Just because refinancing is the “go-to” solution you are hearing a lot about right now doesn’t mean it is the right step for everyone. As with most major financial decisions, there are multiple factors to consider. That can feel overwhelming. There are a large number of calculators online that can be useful. But they are only helpful once you have thought carefully about your goals.
Financial planning is more than retirement, wealth management, and estate planning. We’re here for you now, and willing to help you evaluate and consider any financial decision. Let us help you spell out your immediate and overall financial goals and then do the numbers that will help you determine if refinancing is a good idea for you in the current situation.