This is a very important question which all homeowners should ask themselves both at the start and towards the end of the process of refinancing. The answer to this question can spur the homeowner to investigate refinancing further or convince the homeowner to table the thoughts of refinancing for the moment and concentrate on other aspect of owning a home.
Establish Financial Goals
This should be the first step in the process of determining whether or not refinancing is worthwhile. Without this step, a homeowner cannot accurately answer the question of the worth of refinancing because the homeowner may not fully understand his own financial goals. While financial goals may run the gamut from one extreme to another the most basic question to ask is whether the more significant goal is long term savings or increased monthly cash flow. This is important because refinancing can usually achieve these two goals.
Do You Want to Save Money in the Long Run?
Homeowners who establish a goal of saving money in the long run should consider refinancing options such as lower interest rates or shorter loan terms. Both of these options can considerably lower the amount of interest the homeowner is paying on the loan. This is significant because paying less interest will result in a greater cost savings.
Consider an example where a homeowner has an existing debt of $100,000, an interest rate of 6.25% and a loan term of 30 years. Just by reducing the loan term to 15 years the homeowner can significantly decrease the amount which is paid in interest during the course of the loan. However, this option will also result in an increase in the monthly payments made by the homeowner. Therefore this type of refinancing option may only be available to those who have enough 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 to them each month. These homeowners might consider a refinancing option in which they are able to extend their loan terms. This means they will be repaying the existing debt over a longer period of time. The homeowner will pay more in interest in the long run but will achieve their goal of lower monthly payments and an increased cash flow.
How Will refinancing Affect Tax Deductions?
This is another serious consideration for homeowners who are interested in investigating the possibility of refinancing. The interest paid on a home loan is often tax deductible. A homeowner who refinances in a manner which results in less interest being paid annually may adversely affect their tax strategy. The implications of this type of chance can be amplified for homeowners who were previously just below a significant tax break line. A significant decrease in the amount of interest paid will mean a significant decrease in the deduction the homeowner is allowed to take. This reduced deduction can put the homeowner in an entirely different tax bracket and could end up costing the homeowner money in the long run. For this reason, homeowners who are considering refinancing should have a tax preparation professional determine the ramifications refinancing will have on their tax return before a decision is made.