What To Consider Before Refinancing To Repay Debt
Deciding whether to refinance a mortgage to repay debt or continue with an existing debt repayment schedule may seem like an easy choice for most people. However, the decision involves quite a bit of foresight and evaluation based on the following factors:
1) Will a refinance repay all or just part of my existing debt? If you can refinance at today's low rates and repay all of your debt, you should move ahead with a refinance without hesitation. However, if the recent devaluation in property values will leave more than 25% of your existing debt unpaid (or any amount that will result in continued payments) consider waiting until your property value increases to a level where all debt can be repaid (yes, values will recover). This is simply to avoid future hardships that leave you facing the possibility of filing for Chapter 13 bankruptcy except now you have much less equity in your home.
2) Will the costs of refinancing my mortgage get offset by the lower rates and increased cash flow within the first year? One year is a good benchmark to use when determining whether a refinance makes the most sense from a financial point of view. If it will take more than 1 year, consider an alternative way to repay debt unless a refinance is mandatory for cash flow reasons. Unfortunately, it often happens that even a small level of debt gets refinanced for costs that ridiculously high. Worse yet, the debt could have been repaid within a short period of time (less than 3 years) with a bit of discipline (often achieved through automatic transfers or payments).
3) What kind of impact will a refinance having on my overall cash flow? If you are considering a refinance in order to improve cash flow, consider that merely improving cash flow is often not enough to make a true difference to your financial well-being. The improvement should be substantial enough to allow you to put aside (i.e. invest) money as well. This need not be an extraordinary amount, but even a nominal investment amount can help with avoiding future debt problems. If the refinance does not improve your cash flow enough that you can make a regular contribution to a savings account while meeting your basic financial demands, then chances are quite high that you may be better off seeking some kind of debt relief alternative. Without proper cash flow, debt will resurface within 5 years and have a compounding problem on your finances.
These three considerations are merely starting points if you are looking at a refinance as a way to improve your financial health. Although rates are currently low, if a refinance does not have the desired effect, you could be putting your home equity at risk in the short-term.
Debt Trouble? Find tips and advice on debt management at HowToRepayDebt.com.
Chris has more than 16 years of experience in the financial services industry. He is currently the content editor at Home Equity Loan Site.org
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