With lowering of interest rates by the central bank, you are tempted to go for refinancing the home mortgage. Home loan refinance is nothing but availing a new loan to clear the existing loan. The new refinance loan probably comes with lower rate of interest with its own terms and conditions. Is it a good idea to go for refinancing your home mortgage? Before deciding whether or not to refinance, ask yourself the following questions:
Is it due to cheaper interest rates?
The most common answer is that prevailing interest rates are cheaper than your existing rate of interest. Well, then calculate the savings from going in for a lower interest rate. If the savings is significant, then go ahead. However, the longer you are in debt, you end up paying more interest irrespective of interest rate. So, when you are looking for refinance, avail a 15-year tenure mortgage. If you find it difficult, then go for 20-years tenure and make it a point pay extra whenever possible so that you avoid staying in debt longer period.
Is it to lower your EMI?
Do note that lowering your monthly equated monthly installments (EMI) and saving money are two independent activities. By lowering your monthly payment, in fact you are most likely to increase the total cost of owning the home. If your objective is to reduce the amount of interest you pay on your mortgage, your goal is to pay off your mortgage as quickly as possible. By refinancing and extending the tenure of the loan you end up paying much more on servicing the loan in the form of interest over the life of the loan. If your current financial condition is not permitting you to pay your current mortgage, refinancing could be a good way to adjust to your new
economic reality. If your financial situation improves, remit as much as possible to your mortgage payment to
How old is your current mortgage?
In the first couple of years of your mortgage, a significant part of your EMI payment goes towards servicing the loan, i.e., towards interest. So, if your mortgage is within the first few years then the mortgage balance might not have reduced much and if you refinance, your balance will remain the same. Hence, if your current mortgage loan is within the age of one to three, it is not advisable to go for refinancing.
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Have you checked closing cost?
Generally, people buy homes to build wealth as it is a real asset. However, the closing costs associated with refinancing the mortgage could actually add considerable costs. As your goal is to save money, you should avoid financing the closing costs. Further, if you refinance, make sure you be associated with the same lending agency to get the benefit of amortisation. Frequent refinancing could actually make owning a home as a worse economic decision than renting.
Ask yourself these above questions before going for refinancing your home loan.
The writer is associate professor of finance & accounting, IIM Shillong.