Refinancing has become a popular decision for homeowners in 2020, as interest rates are at historic lows. You might hear about friends or family refinancing and wonder if you should be doing the same.
While refinancing can be an effective way to reduce your mortgage interest rate or monthly payment, there are some situations in which refinancing might be a bad idea. If you’ve been considering it, you may want to keep these situations in mind and consider whether refinancing is really the right financial move for you.
Is refinancing worth it?
Refinancing your mortgage is the process of replacing your existing home loan with a new one. This new mortgage comes with a new interest rate and new payment terms, and often a new lender. You’re probably wondering why people do it.
When is it worth it to refinance your mortgage?
One of the most popular reasons to refinance is to reduce your mortgage interest rate. Rates in 2020 are historically low, and many people are taking advantage of this to lock in lower interest rates on their mortgages.
Someone might also refinance a mortgage to lower their monthly payments. If your financial situation has changed and your current mortgage payment has become unaffordable, refinancing and extending your loan term can reduce your monthly payment.
Other reasons to refinance might include removing PMI if you’ve increased your equity in your home, changing your loan type (switching from a variable to a fixed rate, or vice versa) or accessing some cash with a cash-out refinance.
[ Read: Best Refinance Rates ]
Reasons not to refinance
Refinancing can be an effective way to save money over the life of your mortgage. But refinancing isn’t for everyone — there are some situations where it just doesn’t make sense.
Costs behind refinancing
Refinancing your mortgage comes with a lot of additional costs, both in the short-term and long-term. Refinancing won’t save you money right away. Because of the closing costs, it’ll likely take you years to break even. Plus, if you extend the life of your mortgage or refinance when you have little equity in the house, interest and private mortgage insurance can also be costly.
Just like with any other mortgage closing, you’ll have to pay closing costs to finalize your refinance. Closing costs can amount to between 2% and 5% of your loan amount on average — or from thousands to tens of thousands of dollars.
Typical closing costs include:
- Loan application fee
- Appraisal fee
- Inspection fee
- Origination fee
- Attorney fees
Most of the time, closing costs are due at the time you sign the final loan documents. If you’re thinking of refinancing to put more money in your pocket, be aware that it could be years before you break even.
In addition to the closing costs you’ll pay, there are other costs to refinance your mortgage as well. First, you may actually end up paying more in interest in the long-run. Let’s say you have a 30-year mortgage that you’re currently 15 years into repayments on. You’ve already paid a considerable amount in interest.
Now let’s say that you decide to refinance into a new 30-year mortgage. The lower refinance rate may not help you in that case because you’ve doubled the amount of time it’ll take you to finish paying off your mortgage.
Refinancing can also be costly when you have less than 20% equity in your home. In that case, you’ll likely have to pay private mortgage insurance (PMI), for many years, so it may be worth waiting until you have more equity in your home.
Your credit score needs improvement
Your credit score is going to be one of the most important factors in determining whether you can get a refinance loan. Even if you can qualify for a loan with a bad score, you probably won’t be eligible for the best interest rates. At that point, the refinance might not be worth it.
If your credit score needs some improvement, you’d probably be better served spending some time boosting your score. A few ways you can increase your credit score are to:
- Make all of your monthly payments on time
- Reduce your credit utilization, either by paying off debt or increasing your available credit
- Find any dispute any errors on your credit report
You aren’t in it for the long run
Because of the additional costs, it can take years to break even on your refinance. If you aren’t planning to stay in the home long enough to enjoy the perks of the lower interest rate, then a refinance might not be the best option for you.
Run some numbers and figure out how long you would have to stay in the house to save money — and then decide whether you can commit to staying for that long.
To figure out how long it’ll take you to break even on your refinance, divide your closing costs by your total monthly savings. You can also use a mortgage refinance break-even calculator to help you do the math.
Tips for refinancing
Are you considering refinancing your mortgage? Here are a few tips you’ll want to follow as you get started.
[ Read: How to Refinance Your Mortgage ]
Decide why you want to refinance.
Are you refinancing in the hopes of getting a lower interest rate? Or is your goal to lower your monthly payment? Go into the process knowing why you really want to refinance. That way, you’ll know exactly what type of loan offer you’ll need to make a refinance worth it.
Shop around for the best rates.
Between traditional banks, credit unions and online lenders, there are plenty of options available for mortgage lenders. Spend some time shopping around to make sure you get the best rate.
Pull your credit report beforehand.
The last thing you want is to apply for a refinance loan and find there’s an unwelcome surprise on your credit report that may prevent you from getting a good deal. Pull your credit report ahead of time so you know what to expect.
Do the math and decide if it’s worth it.
Depending on the type of deal you can get on your refinance, it’s not always worth it. While you may be able to get a lower interest rate, the other associated expenses may mean you’ll still pay more over time. Do the math to ensure that you’re accomplishing your ultimate goal with the refinance.