Refinancing your mortgage often makes it cheaper to pay off your mortgage. However, to make refinancing profitable for you, make sure your new loan matches your needs.
To help you make the right choices about your loan refinance, personal finance guru Suze Orman has a simple rule she advises everyone to follow.
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Suze Orman’s rule is about choosing a new loan
On her blog, Suze Orman says that when it comes to refinancing, “never extend your total payback period beyond 30 years.”
This rule is important to know because people often don’t refinance a loan in the first year or two after getting a mortgage. Instead, many refinance after making payments on their loans for a while.
When you go through the refinancing process, you are applying for a brand new loan. You choose the repayment term for your refinance loan. Most often, you choose between a 15, 20 or 30 year refinance loan.
If you follow Orman’s Rule, when choosing your new loan term, you make sure that the total your mortgage repayment term is no more than 30 years – and that includes the time it takes to pay off the new loan and time to pay off your existing loan.
If you made payments on your mortgage for 12 years and chose a 30-year refinance loan, you would pay off your mortgage for a total of 42 years. To follow Orman’s advice, you would choose a 15-year loan. Then, when the new loan is combined with your old loan, you will make mortgage payments for a total of 27 years.
An extended loan can cost you dearly
Orman advises this because otherwise a refinance loan can cost you money even if you lower your interest rate. Following this rule makes sure that when you get a new loan, you don’t spend more time paying interest to the bank.
“Otherwise, even with the lower interest rate on the new loan, there’s a good chance your total interest payments over the life of both loans will be more than interest if you just hold on to your mortgage.” current and pay it off in 30 years, ”Orman says.
A loan with a longer repayment term might look appealing when comparing rates because your monthly payments would be lower than your current loan, but Orman thinks you need to get the big picture. Much lower monthly payments are not a good thing if they mean you are spending more money and time on the loan, and more time to own your home for free and safely.