How Refinancing A Home Loan Can Actually Hurt You
5 August 2006Money Keg has a lengthy and interesting post on how interest works in bank loans. It’s a good read, and well-recommended for anyone with loans on a house or car. He makes several points, and the one that most interested me was at the bottom:
But what is most troubling is the fact that when a borrower re-fi’s his home or pays off the existing mortgage and buys a new house with a new mortgage, he is essentially starting the process all over again. That is, paying mostly interest and virtually none of the principal on the loan. This means that the average American’s payment of interest continues throughout his life. His proportional share of interest for items such as cars, boats, homes, etc. usually stays right around 20%-25% his WHOLE life! Let this sink in for a second and realize that because every dollar is financed, (you either earn or forego those earnings), you are literally at the mercy of the banking system.
This is a very good point about the way people tend to keep their home loans going forever. It’s like an endless conveyor belt, with refinancing starting the 30-year period over and over again, so that you never truly own the house. There is a never-ending debate on whether it’s really a good idea to put money into paying off your house as opposed to investing it instead. But I tend to think that it’s very valuable going into retirement to have a home with no debt on it. You can sell-down, which is when you sell an expensive house and move to a less expensive area, pocketing the difference in price as part of your retirement fund. You also get to avoid paying a mortgage, cutting your expenses dramatically.
But if you keep jumping back on the treadmill for a lower interest rate and never pay the thing off, you can’t ever get to that point. You’ll hit retirement owing just about as much as when you bought the house.
My recommendation: if you want to pay off your house, when you refinance you should keep making the old payment. If you paid $1400, and you save a bunch and get the payment down to $1100 with lower interest rates, keep sending in $1400 a month - all your savings will go to making that house yours, and you won’t get lulled into paying an endless amount of interest.
Discuss this on the Free the Drones Forums here.
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