This is a very important question that all homeowners should ask themselves at the beginning and end of the refinancing process. The answer to this question can either prompt a homeowner to investigate refinancing further or convince a homeowner to put the idea of refinancing on hold and focus on other aspects of homeownership.
Establish financial goals
This should be the first step in determining if refinancing is worth it. Without this step, the homeowner will not be able to accurately answer the question of the value of refinancing because the homeowner may not fully understand their financial goals. While financial goals may vary from one extreme to the other, the most basic question to ask is whether the more important goal is long-term savings or increasing monthly cash flow. This is important because refinancing can often achieve both goals.
Do you want to save money in the long run?
Homeowners who have established a goal of saving money over the long term should consider refinancing options, such as lower interest rates or shorter loan terms. Both of these options can significantly reduce the amount of interest a homeowner pays on their loan. This is very important because paying less interest will result in greater cost savings.
Consider an example where the homeowner has existing debt of $100,000, an interest rate of 6.25%, and a loan term of 30 years. Simply by reducing the term of the loan to 15 years, the homeowner can significantly reduce the amount of interest paid over the course of the loan. However, this option also results in an increase in the homeowner’s monthly payments. Therefore, this type of refinancing option may only be available to those who have sufficient cash flow to compensate for the increase in monthly payments.
Do you want to increase your monthly cash flow?
Some homeowners may have a chosen goal of increasing their monthly cash flow. For these homeowners, the overall cost savings may not be as important as having more money available each month. These homeowners may be considering refinancing options where they are able to extend the term of their loan. This means they will be paying off their existing debt over a longer period of time. In the long run, homeowners will pay more in interest, but will achieve their goal of lower monthly payments and increased cash flow.
How will refinancing affect tax deductions?
This is another serious consideration for homeowners interested in investigating the possibility of refinancing. The interest paid on a home loan is usually tax deductible. If a homeowner refinances in a way that results in lower annual interest payments, it could have a negative impact on their tax strategy. The impact of this type of opportunity could be magnified for homeowners who were previously just below the line of significant tax deductions. A significant reduction in interest paid will mean a significant reduction in the deduction allowed to the homeowner. This reduced deduction can put a homeowner in a completely different tax bracket and could ultimately cost the homeowner in the long run. Therefore, homeowners who are considering refinancing should have a professional tax preparer determine the impact that refinancing will have on their tax return before making a decision.