Refinancing a home loan can be a very smart financial decision. A mortgage is the biggest debt for most people. If you can lower your borrowing costs on such a large debt, you could potentially save tens of thousands of dollars in interest over time.
But refinancing is only smart if you do it right. And when discussing home loan refinancing, personal finance guru Suze Orman warned homeowners were making a “huge mistake” that was driving her “so mad.” So what’s the mistake she said “really wrong?” This is a simple solution that many banks encourage borrowers to take.
Suze Orman thinks this refinancing operation is “very bad”.
According to Orman, “The big mistake is that after spending years paying off their existing 30-year mortgage, people then refinance into a new 30-year mortgage.”
You see, when you refinance a mortgage loan, the default loan option offered by most banks is a new 30 year loan. But most people had a 30 year mortgage in the first place. This means that if you don’t refinance before you’ve been in your home for a while, your payment period will be much longer.
Suppose you got your original home loan ten years ago and decided to refinance to take advantage of a new, lower loan rate available. The bank may suggest that you get a 30 year refinance loan. But it will reset your debt repayment clock.
Instead of being mortgage free in 20 years, as you would have been if you had kept your current loan, you will be loan free in 30 years. You will end up paying on your home loan for a total of 40 years.
Those 10 extra years of interest payments that you added to your home loan could cost you a fortune in extra interest in the long run, even if you managed to lower the interest rate on your existing loan by refinancing it.
To avoid this, Orman has a simple rule. Borrowers who refinance should not extend the total repayment period of their mortgage beyond 30 years, which includes time already spent on the original loan. So in the example above where you are refinancing after a decade, you would want to choose a 20 year refinance loan instead of a 30 year loan.
Now she recognizes that sometimes you will have an odd number of years left on your loan. If you’ve only been paying off your loan for six years, for example, the bank probably won’t give you a 24-year mortgage. But his advice in this situation is to take the loan with the closest term and make additional payments to ensure that you have paid off your entire balance within the initial 30-year period.
Homeowners need to take this warning to heart and make sure they don’t make a costly refinancing mistake. While choosing a loan with a lower rate and a longer repayment period might seem like a good deal if it lowers your monthly payments, it is not necessarily the best solution if it puts you in debt longer and means you end up. pay a lot more. interest over time.