Refinancing myths and how to avoid problems later

Home refinancing should not be part of your plan when you borrow

Buying a house is expensive; it’s the most expensive thing most people will buy. This situation has become worse with the explosive growth in housing prices during the last few years. The median price of a home in Los Angeles is now in the range of $500,000, an amount that would have been unthinkable just ten years ago. Along with the increase in prices has come an increase in interest rates, making the purchase of housing a more expensive proposition than ever.

There are always solutions to real problems, and the lending industry has a history of being creative.  If you can’t afford a 30 year loan, perhaps you can afford a fifty year mortgage instead! Along with such lengthy loans are a huge array of flexible loan products with adjustable rates. Some adjust within a short period of time, others over a longer period of time and some, like the Option ARM, even offer a variety of payment options each and every month. But buyers should be a bit wary of taking out such loans, as they do come with risks. The Option ARM is particularly risky, as making only the minimum payment will actually cause the amount you owe to increase over time.

Many buyers are steered to such loans by their lenders, who are always eager to sign people up. And why not? Lenders make money when they issue loans. So they tend to encourage their customers to take out whatever type of loan will allow them to buy the home they want. But what if the borrower expresses concern about the fact that the payments might increase to a point of unaffordability?

The response is usually the same: “You can always refinance later.”

That is both true, and false. Millions of Americans have refinanced in recent years, as interest rates temporarily dropped to levels not seen since the 1960’s. But those rates have gone back up now and the refinancing frenzy has come to a halt. And no one knows where interest rates will go in the future. In the late 1970’s, interest rates for home loans were seen in the 15% range. That figure seems unthinkable today, but there is no reason to assume that we can’t see them again.

That means that if you buy your home today with an adjustable rate mortgage that you can only barely afford, there is no reason to automatically assume that you can refinance it later with terms that suit you better. You may be able to get a better loan three, four or five years from now, or you may find out that the rates have gone up tremendously, leaving you in a worse situation than you are now.

What this means for buyers is simple. When you take out a loan to buy a house, you must make sure that you can afford it today. And you must make sure that you can afford to pay for this house with loan terms that will allow you to eventually retire the loan while making payments each and every month that you can afford today.

If you cannot, then you cannot afford the house. It’s that simple.