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Pros and Cons of Refinancing Before You Retire

When the clock is ticking down to your retirement date, your focus should be on getting your financial ducks in a row. And if cutting back on expenses is a priority, a refinance may be one of the moves you’re considering. Refinancing may makes sense if you’re trying to snag a lower interest rate or reduce your monthly payments, but like anything else, timing is everything. If you’ve only got a few years left until you hit your golden years, you’ll want to weigh the pros and cons carefully before pulling the trigger.

Find out now: Compare refinance mortgages

Pro #1: You’ll Have More Wiggle Room in Your Budget

Lowering your overhead costs may be a necessity if you expect your income to take a dip once you retire. If refinancing means a substantial reduction in your payments, it can make a serious difference in your monthly cash flow. Going ahead with the refinance before reaching the point where you actually need that extra breathing space gives you more money to bulk up your emergency savings or max out your retirement accounts.

Con #1: Refinancing Isn’t Free

When you refinance, you’re taking out a new loan, which means you’ll be on the hook for paying the closing costs all over again. Closing costs typically add up to anywhere from two to five percent of the loan value, so if you still owe quite a bit on your first mortgage, you could find yourself shelling out several thousand dollars to seal the deal. Depending on how much you have to pay, it may take anywhere from three to seven years to recoup the expense, negating some of your savings in the process.

Find out now: Refinance Closing Costs Calculator

Pro #2: You Can Streamline Your Mortgage Repayment

If you’ve taken out a home equity loan in addition to your original mortgage, refinancing allows you to combine the two into a single payment, which may be a more affordable option than paying them separately. In situations where your home equity loan or line of credit is tied to a variable rate, refinancing also gives you the opportunity to lock in a low fixed rate. This gives you the stability of knowing what your payment will be each month.

3 Signs You Should Be Refinancing

Con #2: The Loan Repayment Period May Be Extended

One of the issues you’ll have to decide when refinancing is what type of mortgage term to go with. The shorter the term, the higher the payment, but you’ll be paying your home off at a much faster pace. If you’ve got 10 or 15 years left on your current mortgage and refinance to a 30-year term, your payments will likely end up being much lower, but you’ll be faced with the prospect of owing money on the home well into your retirement.

Pro #3: You Can Cash out Your Equity

Aside from the potential savings involved, refinancing is also a popular choice for homeowners who want to tap into their equity. Once you get your hands on the cash, you can use it to pay off any high-interest debt (such as from credit cards) that’s still lingering, or tackle those home improvement projects you’ve been putting off. Getting rid of debt puts you in a prime position to pare down your budget once you retire, and upgrading the property can help you out if you eventually decide to sell.

Con #3: Taking out Your Equity Isn’t a Magic Bullet

Pulling equity out of your home to pay off burdensome credit card debt doesn’t make sense if you don’t have your spending under control. Unless you’re actively planning out your budget, tracking your purchases and setting goals, you could end up running up the balances all over again. When the time comes to leave the 9 to 5 behind for good, you may be no better off than you were before you refinanced.

Top 5 Strategies for Paying off Your Mortgage Early

Pro #4: You’ll Still Get a Tax Break

Currently, homeowners are able to deduct the interest they pay towards their mortgage each year. When you refinance into a longer mortgage term, you’re also extending the amount of time you’re able to claim the deduction. If you’re worried about your tax bracket increasing once you start drawing on your retirement income, it pays to take advantage of every possible write-off.

Con #4: There May Be a Penalty

Before you move ahead with a refinance, you’ll want to review your existing mortgage terms carefully to see if there’s a prepayment penalty. Generally, prepayment penalties range from two to four percent of the loan, and not all lenders charge them. If you’re having to pony up a penalty on top of the closing costs, you’re diminishing any potential savings from the refinance even further.

The Bottom Line

Refinancing definitely has its advantages, but you have to be aware of what the potential downsides are going forward. Moreover, you need to avoid some of the common refinancing mistakes inherent in the process.

Taking a look at the bigger retirement picture can help you decide where a refinance fits in. A financial advisor can be a big help in evaluating your full financial situation and figuring out whether a refinance actually aligns with your long-term goals. A matching tool like SmartAsset’s SmartAdvisor can help you find a person to work with to meet your needs. First you’ll answer a series of questions about your situation and goals. Then the program will narrow down your options from thousands of advisors to three registered investment advisors who suit your needs. You can then read their profiles to learn more about them, interview them on the phone or in person and choose who to work with in the future. This allows you to find a good fit while the program does much of the hard work for you.

Photo credit: flickr

Rebecca Lake Rebecca Lake is a retirement, investing and estate planning expert who has been writing about personal finance for a decade. Her expertise in the finance niche also extends to home buying, credit cards, banking and small business. She's worked directly with several major financial and insurance brands, including Citibank, Discover and AIG and her writing has appeared online at U.S. News and World Report, CreditCards.com and Investopedia. Rebecca is a graduate of the University of South Carolina and she also attended Charleston Southern University as a graduate student. Originally from central Virginia, she now lives on the North Carolina coast along with her two children.
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