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When is Refinancing Your Mortgage a Bad Idea? | Mortgages and Advice

Key Takeaways:

  • Refinancing makes sense if you can score a lower interest rate or repay your mortgage faster.
  • Refinancing isn’t the best choice when interest rates are high or if your income and employment are unstable.
  • Before refinancing, it’s important to evaluate your financial goals and determine your break-even point. 

If you’re looking for ways to lower your monthly mortgage payments or tap into the equity in your home, you may be considering refinancing. Refinancing your mortgage has many benefits, but there are trade-offs to consider first. Before you move forward, take the time to consider whether refinancing will really benefit you financially.

Understanding Mortgage Refinancing

When you refinance, you replace your current mortgage with a new home loan. Many people refinance to take advantage of lower interest rates and reduce their mortgage costs.

If you currently have a 15-year mortgage, you can refinance to extend your loan terms and lower your monthly payments. Extending your loan terms will increase the amount you pay overall but will lower your monthly mortgage payments.

You can also do a cash-out refinance, which involves borrowing from the equity you’ve built in your home. To do this, you’ll refinance your home for more than you currently owe on the mortgage and receive the difference in cash. You might use these funds to finance a home improvement project or pay down high-interest credit card debt.

When Is Refinancing A Mortgage a Bad Idea?

Refinancing comes with many benefits, but it isn’t the best solution for everyone. Whether it makes sense for you depends on your financial goals and the current economic conditions. Let’s look at three scenarios where refinancing may be a bad idea.

Refinancing with a High-Interest Rate

Melissa Cohn, executive mortgage banker at William Raveis Mortgage in New York City, says you shouldn’t refinance unless you can secure an interest rate that’s 0.75% lower than your current rate. If your new interest rate will be higher than what you already have, refinancing probably isn’t a good choice because it’ll cost you more over the life of the loan.

You Plan to Move Soon

Even if interest rates are low, refinancing isn’t a good idea if you plan to move in the next couple of years. That’s because if you move, it’ll take you too long to break even on the costs that come with refinancing.

“There are closing costs associated with refinancing, so you need to take that into account. If you refinance to a new 30-year loan after you have had a mortgage for a few years, you are starting all over again with the amortization of the mortgage,” says Cohn.

Unstable Employment and Income

If you’re concerned about losing your job or your income fluctuates from month to month, refinancing probably isn’t a good idea. Refinancing is best for borrowers who are in a stable financial situation.

You won’t immediately save money by refinancing since you’ll have to come up with closing costs. And if you refinance to shorter loan terms, this could stretch your budget and unnecessarily put your home at risk.

Hidden Costs of Refinancing a Mortgage

Most people refinance to save money, so it can be a shock to end up spending between 3% to 6% of your total loan amount on closing costs. That means if you’re taking out a $400,000 mortgage, you could end up paying between $12,000 and $24,000 in closing costs.

Refinancing costs vary depending on the lender, but the closing costs typically include things like an application fee, origination fee, inspection fee and an attorney review fee. And some lenders may charge a prepayment penalty since you’re paying off the old loan early.

Useful Tips and Advice on Mortgage Refinancing

“Refinancing costs money, and in many cases, it can add up to a substantial amount,” says money coach and certified financial planner Ohan Kayikchyan. If your primary objective is to save money, he recommends taking the following steps before refinancing:

  • Determine your break-even point. Your break-even point is how long you’ll need to stay in the home before you recoup the amount spent on closing costs. For example, if you spend $5,000 on closing costs and save $100 per month, it’ll take you 50 months to break even. If you know you won’t be staying in your house that long, refinancing doesn’t make financial sense.
  • Have a plan for your savings. If your goal is to save money, it’s important to have a plan for what you’ll do with any money you free up after refinancing. For example, will the funds go toward investing or education costs? Or is this just a way to free up your monthly budget? 
  • Check for prepayment penalties. If refinancing lowers your interest rate but increases your loan terms, you will end up paying more over the long run. Check to see if your mortgage comes with a prepayment penalty. If it does, you can always ask your lender to waive it. 

Sarah Goldberg
Sarah Goldberg

Sarah is a seasoned financial market expert with a decade of experience. She's known for her analytical skills, attention to detail, and ability to communicate complex financial concepts. She holds a Bachelor's degree in Finance, is a licensed financial advisor, and enjoys reading and traveling in her free time.

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