Refinancing Tips and Suggestions (do's and dont's)

Refinancing is a process in which you pay off one or more debts by borrowing new money from an existing creditor or a new creditor. It is sometimes suggested as a good way for people with financial problems to address their difficulties.

We recommend that you be very careful when refinancing debts. Refinancing an unaffordable amount of debt is one of the most tempting but risky steps you can take when you have financial problems. Many refinancing loans will hurt you more than they help.

Refinancing's attraction is that it seems to resolve your financial problems even though your income and your expenses do not change. The stroke of a pen pays off creditors who have been threatening action against you. After refinancing, you only have to make one monthly payment to a new creditor who is not (yet) threatening anything.

The disadvantages of refinancing are often hidden. Problems occur because of the complex mathematics that sometimes govern the refinancing process, including hidden fees and costs, and because the new loan may give the creditor ways to force payment and seize your property that were not available under the prior loan. There are even times when a refinancing deal is nothing more than a scam to steal your home or other property. Each potential refinancing deal must be reviewed carefully on its merits based on the principles discussed below.

Twelve simple refinancing rules:

1. When in doubt, do not refinance or consolidate debts. Refinancing deals almost always come with significant costs. These costs will usually just make matters worse in the long term.
   
2. Do not let debt collectors pressure you into refinancing. Debt collectors may try to scare you into refinancing because they have no other way to get their money.
   
3. Never (or almost never) refinance unsecured debt into secured debt. For example, do not take out a mortgage on your home to pay off credit card or medical bills. Unsecured creditors rarely can do anything to seriously hurt you if you fail to pay. By trading in unsecured debt for a mortgage loan, you face loss of your home if you continue to have financial problems. Do not refinance unsecured debt into secured debt even if this allows you to lower the interest rate you are paying.
   
4. Do not refinance utility debts. Most utility companies have flexible repayment plans and you can usually work something out with them instead of paying off utility debts through refinancing. Even if you cannot work out a payment plan, it will almost always be cheaper to get the utility turned back on than it will be to pay the refinanced debt.
   
5. If you have an existing debt with a finance company or high-rate second mortgage company, do not refinance that debt with the same company. Ask the company to agree to lower payments on the existing loan, but do not allow the creditor to refinance that loan, which may involve prepayment penalties, new closing costs and perhaps even a higher interest rate. Never allow the company to add new security--such as your home.
   
6. Do not turn your car loan into a second mortgage unless you would rather lose your home than your car. If you are in danger of losing your car, you may be tempted to pay off your car loan by taking out a second mortgage on your home. You may save your car temporarily this way, but you are putting your home in danger. Although repossession is bad, foreclosure is worse.
   
7. Do not refinance a loan with household goods collateral into a second mortgage loan. Not only is your home worth more than your household goods, but it is very hard for a lender to repossess your household goods.
   
8. Do not refinance low-interest debts with higher interest loans. You should always evaluate the interest rate on the new debt and look for a lower rate than on the old debts. Furthermore, the "APR" (annual percentage rate) of the new loan must be lower than the stated interest rate of the old loan, or you will be losing money. You have already paid for certain up-front fees in the old loan, and you must make sure that a new lower rate is actually lower after both the old and new fees are accounted for.
   
   Also remember that the interest rate is not the only consideration when evaluating a loan. Other fees, charges and expenses that are not considered interest may make a loan that looks cheaper into one which is actually more expensive.
   
9. Do not include your long-term first mortgage in a refinancing package. Do not let second mortgage lenders pay off your first mortgage and give you a new mortgage equal to the first mortgage plus the new loan amount. The only exception is if the new mortgage is for the equivalent length of time and the interest rate is significantly lower than the old first mortgage--to offset prepayment penalties and fees and charges.
   
10. Do not refinance loans when you have valid legal reasons not to pay that debt. If you have a legal defense to repayment of a debt, you can raise that defense in court. If you refinance with a new lender, the defense will not be available against the new creditor. You should get legal help to see whether you have a valid defense before entering the refinancing deal.
    
11. Watch out for scam refinancing companies. Refinancing involves great potential for hidden costs, fees and other unfair loan terms. Even some reputable lenders make unfair refinancing deals. When in doubt, get help in reviewing the loan before you sign anything. You can walk away from a bad deal even at the last minute. A lender that is unwilling to let you get outside help should not be trusted. Another way to avoid scams is never to let a contractor or salesperson arrange financing for you and be wary of mortgage brokers. Unfortunately many brokers find refinancing deals that involve big commissions for them rather than good loans in your best interest.
    
12. You can cancel any refinancing deal that involves a mortgage on your home. In most refinancings in which you give the lender a mortgage, federal law gives you the right to cancel for any reason for three days from the date you sign the papers. Make sure you cancel in writing before the deadline. You can, but need not, use the cancellation form provided by the lender.