6 Signs You Are Refinancing for the Wrong Reasons

Many argue there has never been a better time to refinance. The equity is there for the taking, and there’s nothing like getting a solid cash infusion deposited into your bank account to move forward with your big life plans and dreams.

While it has gotten a bit trickier to pull equity out of property these days, it is still doable.

I recently refinanced two properties. I probably waited longer than I should have to do it. My mortgage payments were comfortably low, and my loan amount went way down while my equity grew.

Once I had a specific strategy to move my investments from being bulky in appreciation to cash flow, it made sense to refinance. When I did, I hardly noticed that my payments increased, and my plan to put the money into cash-flowing assets would propel me toward my financial goals.

But that isn’t always the case.

When Is It a Bad Idea to Refinance?

Now is when the car screeches to a loud and sudden STOP. Like with all financial transactions, you need to take a step back and look at the whole picture. Sometimes what seems like a great idea does not actually make a whole lot of sense. (Or should I say cents?)

1. You are passionate about shiny objects.

You want to buy a new car. You are over the old Prius you have been driving for eight years, and you could take $40,000 out of your house and get a new one. You’d get all the bells and whistles, and a new car will smell so good. And imagine never having to go to the mechanic except for an oil change? Besides, you love the gray color that just came out.

I can’t argue. It sounds pretty good.

Now, let’s look at the flip side. First, as soon as you drive that fancy new car home, you’re losing value. Cars are by far the worst investment you can make. Their value depreciates quickly and never stops going down.

If you don’t have the extra money in hand for a car, keep on driving one that is in your budget. (And no—leasing a car is not a better option.)

You also need to keep in mind that whenever you’re doing a cash-out refinance, you’ll owe more on your house and your payment will increase. So, if your goal is financial freedom and you do decide to refinance, wouldn’t it make more sense to use those funds to invest in another property?

As Dave Ramsey says, “If you will live like no one else, later you can live like no one else.”

2. You don’t know the difference between good and bad debt.

You have had student loans for years. Isn’t it time to get rid of them?

I can’t tell you how many people I know who made a lot of money and paid off their student loans only to be broke afterward.

Your interest rates on student loans are low. Paying off your student loans does not leave you with an asset like real estate. It just gets rid of a student loan.

It is best to continue paying the loan off slowly and investing in another asset. Remember, assets make you wealthy, paying off student loans does not. Your student loans bought your education, and you cannot put a price tag on that.

Case in point, not all debt is bad. The sooner you adopt this belief, the faster you will make a fortune in real estate.

3. Your focus is on one great day instead of a financially free life.

Let’s say you’re getting married. So many people fall in love with the idea of a fairytale wedding. And let’s not forget the honeymoon!

Why not pay for it with a cash-out refinance of $30,000-$50,000? Oh heck, it is once in a lifetime! How about $70,000 to buy you one day you will never forget and a honeymoon too?

It sounds so fun, but that increased payment and blowing the money on one (albeit wonderful) day will not make a financially free ever after.

4. A friend wants you to invest in a new business idea that will make you a ton of money.

I do not want to be a Debbie Downer, but if it sounds too good to be true, it might be.

All investing carries an element of risk. As a seasoned real estate investor, I am the first to agree that no risk equals no reward.

Still, the first thing to do is evaluate. If the business venture seems like a no-brainer, then it may be worth the risk of a higher mortgage payment.

But the additional expense to the mortgage payment will mean less cash flow. If this may create a financial hardship, you need to decide how sound the investment is and how soon it will start making money. While you always want to be moving your money to make more money, you do not want to over-leverage to the point where you lose your home or investment property.

Stocks are more of the same. These investments can be very lucrative if you can afford them. However, taking equity out of your home in a refinance for this sole purpose places an incredible amount of risk and stress on your pocketbook.

The difference with real estate is that you can generally find a deal that makes sense based on the variables. For instance, maybe you refinance out $20,000 and buy cash-flowing property making 12% annualized cash flow.

5. Your old kitchen and bath are intolerable.

A new kitchen with stainless steel counters would give you more space to cook, which you love. A larger bathroom would allow you to put in the beautiful tub you have been dreaming of. All you need to do is refinance! The money is there!

Remodeling a home is fantastic, but a brand new kitchen often won’t add up to a higher sales price to match the investment when you decide to sell.

Trust me—I have made an expensive mistake before. The only difference was that I could afford to make some modifications to my home at the time, knowing there may not be a return on that investment.

These days there is a lot of instability of jobs and income. Redecorating is not a moneymaker, and refinancing for this reason could leave you with a great kitchen you can no longer afford.

6. Interest rates are at an all-time low, and you want a piece of the action.

The economy is currently at a point where people feel short on funds but can still access cash. It may seem like a great idea to take that cash out because you can get it, but without a plan to invest it, you could end up spending it on items you do not need.

If you can comfortably afford your payment now, why would you risk raising the amount owed each month without a solid plan in place?

If you cannot pay your bills, you will ultimately lose your house. So while it may seem like a good idea to grab some fast cash, you need to make sure you are not taking on more than you can handle.

Take risks when you can afford it. Otherwise, have a strategic plan in place to mitigate risk, and make sure you can manage the expense if the numbers do not end up the way you expected.

If you want an expensive wedding or a new car that has no return on investment, please ask yourself what your ultimate goals are. If one is financial freedom, you won’t get there if you have other priorities that don’t include managing your choices.

To be sure, being in a position to refinance is incredible because it means your property has appreciated and earned equity. Make sure you stay on the trajectory to keep that going and think twice to make sure you are refinancing for the right reasons.

How do you decide whether to refinance or not?

Tell us your process in the comments.

Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.