Prior to 2008 current mortgage rates were at their lowest levels in decades and many people were refinancing. At the time I warned that “this trend seems dangerous to me because rather than using this as an opportunity to shorten the life of their mortgage people are just reducing their payments.” Or worse still they were increasing their debt levels by maxing out their home equity.
Why would paying less on your monthly mortgage be bad? Paying less to the bank sounds like a good idea to me! The reason I think this is a bad idea is because many people are using this as an opportunity to increase their debt. Because they can afford the payment on a larger debt they are simply spending up to the limit. People who do this will never get out of debt and will remain slaves to the bank for their entire lives.
1st Choice- Refinance to reduce the life of your loan
Remember the old song “16 tons” which spoke of shoveling coal all day long and just ending up another day older and deeper in debt. Not even being able to die because I “owe my soul to the company store”. Today people have an opportunity to get out from under and they aren’t taking it.
During this time I took the opportunity to use the lower rates to reduce my mortgage from 25 years remaining to 15 years remaining with the same monthly payment. Then I looked at refinancing again. When I was able to reduce it to 10 years.
A 30 year mortgage at 5% will end up costing you almost twice the amount you borrow, over the life of the loan. While a 10 year mortgage at 5% will only cost you about 30% more than the amount borrowed. So in addition to eliminating the aggravation of a mortgage starting 20 years earlier you end up saving roughly 2/3 of the price of your house in additional payments!
- I strongly suggest anyone who can possibly afford the payments to reduce the life of the loan any and every way possible!
- Don’t increase the amount you borrowed unless you absolutely have to.
2nd Choice- Reduce the amount of your payment
If reducing your payment will allow you to pay off higher rate debt like credit cards by all means do it. But don’t fall into the trap of just spending the extra and keeping your cards maxed out. Eliminate interest payments everywhere possible.
Worst Choice- Keep your payment the same and borrow more
By simply refinancing and taking the equity out of your house, this is a sure way to “owe your soul to the company store” in this case the bank. Don’t do it! The common rationale for doing this is to be able to pay off lower cost credit card debt but what you are doing is exchanging short term debt for long term debt. Then most people with credit problems go out and rack up more short-term debt. If you have excessive credit card debt use option #2 to reduce your mortgage payments and use the money saved toward reducing your credit card payments. That way you keep your equity building up and develop the habits necessary to reduce your debt. A one time reduction in your debt is not going to change the habits that got you into debt in the first place.
See the chart from Bankrate.com to get an idea of what the current rates are. If you are paying more than 1% above these rates consider refinancing. Your rates will vary from the standard rates based on your personal financial condition be sure to compare mortgage rates.