It’s tempting to refinance, given today’s low interest rates. Switching to a new loan with a lower refinance rate can cut your monthly payments and free up money for other needs.
But what if you’re close to retirement — does refinancing carry any special risks? We asked financial advisor Laura Scharr-Bykowsky, a member of NerdWallet’s Ask an Advisor network, about the pros and cons of this strategy.
What should people keep in mind about refinancing if they’re near retirement?
All too often, people will only focus on the smaller monthly payment when refinancing mortgages. Remember that each time someone refinances, he or she is taking on a new term. If you have only eight years left on your loan but then refinance to a new 15-year mortgage, your payments may be lower, but you are taking a longer time to pay the loan back and may be paying far more in the long run.
Also, people tend to underestimate the sense of freedom a retiree has when he or she doesn’t have a large obligation like a mortgage in retirement.
People should consider how long they will be in the home, how long they want to carry a mortgage and, most importantly, how much the loan will cost them over the life of the loan, or their life expectancy.
Also, keep in mind that having a lot of equity in your home gives you options in case you develop serious health issues that require paying for long-term health care. If you do a cash-out refinance, in which you borrow against the equity in your home, you could wind up without this potential source of funds.
However, if someone needs to retire early or has a hardship and there is an urgent need to reduce expenses, it may make perfect sense to refinance, especially if he or she has at least 10 years left on the current loan and the current interest rate is substantively higher than the new refinance rate.
Are there situations where it might not make sense to refinance, even to a lower rate, for people in this group?
I would not refinance if you are going to move in five years or are extending the loan out too long, thus increasing the overall cost of the loan. I would also make sure that closing costs will be paid back over a reasonable time frame, say two to three years.
Another issue I occasionally see is when a client wants to refinance in order to free up money for discretionary spending (plastic surgery, travel or an early retirement). That may be a sign of a cash flow problem. People who do this are looking to stretch out their fixed obligations so they can spend more on the flexible, fun items in the budget. Unfortunately, some people tend to spend the savings and then some, and become serial refinancers.
Any other tips for people considering this strategy?
I would emphasize refinancing to a term that’s closest in years to your current remaining term or lower. This ensures you won’t end up paying more over the life of the loan.