I was listening to a sermon about finance a few weeks ago and when the speaker referenced people who manage their money poorly, he mentioned how “they just keep refinancing…”. I realized then that a lot of people might have a misconception about refinancing, assuming it’s always a bad thing.
When someone with poor money management skills is refinancing their home, they are most likely doing what’s called cash-out refinancing. This means they are taking cash out of the value of their home and using it to pay down other debt (i.e. credit card debt), while starting a new loan on their home. I found a great explanation of how cash-out refinancing can propel someone further into debt on Investopedia:
Many homeowners refinance in order to consolidate their debt. At face value, replacing high-interest debt with a low-interest mortgage is a good idea. Unfortunately, refinancing does not bring with it an automatic dose of financial prudence. In reality, a large percentage of people who once generated high-interest debt on credit cards, cars and other purchases will simply do it again after the mortgage refinancing gives them the available credit to do so. This creates an instant quadruple loss composed of wasted fees on the refinancing, lost equity in the house, additional years of increased interest payments on the new mortgage and the return of high-interest debt once the credit cards are maxed out again – the possible result is an endless perpetuation of the debt cycle and eventual bankruptcy.
Sometimes refinancing is a lot more justifiable like when you need to pay for your child’s college tuition or a large medical bill. And sometimes refinancing can even be a good thing like when you use it to lower the interest rate on your mortgage. Investopedia does a great job of summarizing When (And When Not) to Refinance Your Mortgage. So take a look when you get a chance!