I have seen a pattern in the people around me play itself out several times. It's a pattern that ensures their financial slavery. The five year refinancing of their homes. The trap has so many factors going against people that it is surprising that people do it...but they do and so we will discuss it here. What's wrong with the 5 year refi?
1. We have talked about what a complete waste of money PMI is. When you keep your loan from going below the 80% mark, you are making sure that you are always paying PMI. You can't continue to throw money away if you want to make money. PMI is a gift from you to the bank. Does that bother you at all?
2. Do not ever be confused by the "great interest rate" that you are getting. If you have a 6% interest rate, there is only one way to pay that amount of interest. You have to pay off your house in one year. If you don't, you are paying more than 6%. The longer it takes, the more interest you are paying. If you are going to pay for 30 years, then you are talking about something in the range of 180% interest (30 years X 6% a year). Is there anyone out there that wants to pay 180% interest on anything? But that's a discussion for another post.
What I want to get at is this. Take your payment and subtract your PMI, your home insurance, and your taxes. What is left is the amount of interest you are paying. What you will see is that each month, you are paying something in the area of 80% interest in your first few years.
Everytime you refinance your house, you keep yourself paying this incredibly high amount of interest. Think about it each time you make a payment. 80% of your payment is profit for the bank and doesn't help you. Can you really afford to throw away 80% of your money?
3. The last part of this trap is the icing these people put on their cake. They do a refi so that they can pay off all their other bills that have accumulated over 5 years. Pay off medical bills, pay off credit cards, and pay off the old car. They now have a lower overall outgoing payment. This can be good! It really can, if used correctly. It's not great but it can still be worked into a great thing.
But that's not what happens, is it? Gee, now they have more money left over each month so what do they do? Go buy a new car. Run up the credit cards. Live life like they make more money for a year or two and then what? They try to hold out for a few years while the value of their house goes up so that they can get it refinanced and do it all again.
Each refinance doesn't get them ahead, it puts them further behind until there is little chance of ever achieving financial freedom.
Tomorrow: Keeping up with the Joneses.