How Future Plans Should Affect Your Refinancing Choices

Fixed rate or adjustable rate? 15-year mortgage or 30-year? Perhaps you've studied these issues and feel you have a handle on what represents the best choice when you refinance. Perhaps you've even learned something from your original mortgage, and have resolved to do things differently the next time around. Still, before you assume you know the right answer, consider how your future plans might affect your refinancing decision. What you might find is that the "right" answer varies with your circumstances and changes over time. It may depend on what your future plans are. Consider the examples discussed below.

Fixed Rate vs. Adjustable Rate?

Adjustable rate mortgages have been widely associated with recent foreclosure problems, but the truth is that there is nothing inherently wrong with adjustable rate mortgages. Recent problems had more to do with the extreme terms of some of these loans, or the circumstances in which they were made. However, there are many conditions under which adjustable rate mortgages may make sense:

  • If you are planning to move in less than 5 years. A shortened time horizon tends to accentuate the advantage of an adjustable-rate mortgage while minimizing a key risk. That advantage is the teaser rate -- if you are able to get one or more years at a special low interest rate when you only plan on having the mortgage for a few years, in effect you've drastically lowered the average interest rate on the loan. Meanwhile, the risk that you'll get stuck paying higher interest rates in the future is dramatically lowered if that future is shortened by your plans to sell.
  • If you expect considerable improvement in your credit rating in a  few years. If you are refinancing with a shaky credit history, expect to pay more for your loan. However, if you have a solid plan to rebuild your credit, you should have your current budget habits under control and a firm idea of when the black marks on your credit history will start to disappear. If you expect to be able to refinance under better conditions in a few years, you've effectively shortened the time horizon of the loan, and can benefit from an adjustable rate mortgage for the reasons listed above. In any case, when your timeframe is short, make sure the loan doesn't come with a prepayment penalty that can hamstring your plans.

15-Year vs. 30-Year?

If you can afford the payments on a 15-year mortgage, why not take this option (which almost always comes with a lower interest rate) and lower your interest payments over the life of the loan? That makes sense in many situations but consider some conditions that may change the answer:

  • If you face rising expenses in future years. If you anticipate that college or medical expenses might tighten your budget before the mortgage is paid off, you might want to leave yourself some financial flexibility by opting for the lower monthly payments associated with a 30-year mortgage.
  • If you have concerns about your long-term job security. If you are in a high-paying job now, but are not sure what the long-range outlook for your position is, the same logic about budget flexibility applies.
  • You want easy access to your money for investments or other things. Consider that, unlike more liquid investments, it's not easy to get money out of your house once you've put it in. You have to take a loan against your equity, in effect paying the bank to get access to money you've invested in your home.

So the ideal loan varies not only between borrowers but even the same borrowers will probably need different financing depending on their stage of life and their financial plans. A good loan professional can help you with these decisions--one more reason to shop with several until you find one whose expertise and personality you're comfortable with.

Posted By :
Richard Barrington is a freelance writer and novelist who previously spent over twenty years as an investment industry executive.

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