Three Dangers of Refinancing

Mortgage refinances have resulted in plenty of rewards for homeowners. But the risks are becoming more complicated as lenders alter programs and find new ways to drive profits. Understand both sides of the coin before committing a penny to a mortgage refinance.

A mortgage refinance has a Zen-like quality. Risk and reward are like the balance of yin and yang. While a drop in interest rates may hold plenty of reward, there's also the risk of things like high closing costs and a potential increase in property taxes. Here's an overview of the risks you need to take into account when considering a mortgage refinance:

1. Loans in their best interests

Banks and mortgage brokers are paid to produce loans, and they may push you toward a refinance that might not be a proper fit for your financial situation. Any positive point they bring up is likely to have a negative point somewhere. Make sure that you understand all facets of the loan that they're proposing. Consult a financial advisor-be it a professional or knowledgeable friend-before you take the word of someone in the lending industry.

2. ARMs can adjust

If you're looking to increase your cash flow, the prospect of refinancing an adjustable-rate mortgage (ARM) can help you meet your short-term needs. Generally, the rates on an ARM are lower than a 15- or 30- year mortgage and will result in a lower monthly payment. The risk is that the rate of the mortgage could adjust upward at the end of the loan's low-rate introductory period. This could leave you in a tough spot if the rate adjusts too high and you can't make the new payment.

3. Numbers don't add up

The old rule of thumb used to be that if rates dropped 2 percent, you could refinance your mortgage. These days, there are other factors you should consider when you run the numbers on a mortgage refinance, including:

Prepayment penalties: Lenders tack this onto your mortgage in the event that you decide to refinance. Sometimes these fees can be sizable.

Closing costs: Take a close look at all the fees and closing costs that a new loan requires. Will you be able to recoup those costs in interest rate savings? (Don't forget that the average person moves once every five years, so you may not have 30 years to recoup your savings.)

Property taxes: A refinance requires a new home appraisal. The appraisal's dollar value will be reported to your lender, and it may trigger a reassessment of your house. That could spur higher property taxes for you, and could mitigate the value of the refinance.

A mortgage is the biggest financial decision most people will ever make. Be crystal clear that the loan makes solid financial sense before you proceed. Meditate on the yin yang balance of risk and reward before you decide. It's essential if you wish to achieve financial inner peace.