5 situations when refinancing may not be best option
Refinancing your mortgage can save you a lot of money in interest and lower your monthly payment — when the numbers makes sense, that is. But there are times when a seemingly money-saving move like a refinance can backfire. In short, there are times when it doesn’t pay to refinance.
Make sure you study these five common circumstances in which refinancing could be a costly move. You can’t lower your interest rate enough to offset refinancing costs. Lowering your interest rate is likely the reason you’re thinking of refinancing. But refinancing costs money, whether out of pocket or financed into the new loan. You’ll want to make sure you can recoup those costs, which are usually around 2 percent of the borrowed amount, said Mark Ferguson, a real estate agent and investor who runs InvestFourMore.
“You also have to consider that you might be adding more years to your loan,” Ferguson said. “It’s smart to look at the interest you are paying every month versus the principal with the new loan and old loan as well. You might get a much lower monthly mortgage payment with a new loan, but more of that payment might be going to interest than your current loan. That’s a big consideration.” You’re trying to pay off your loan sooner. If you’re making more money since you bought your home, you might be considering refinancing to a shorter-term mortgage, like a 15-year loan, which typically comes with a higher monthly payment but lower lifetime interest costs than a 30-year loan. That could be a great idea. But you might want to consider making extra payments on your current loan to pay it off sooner, thus avoiding refinancing costs but still saving in interest, said Casey Fleming, author of “The Loan Guide: How to Get the Best Possible Mortgage.”
“Again, easy comparison,” said Fleming. He advised calculating how much you have to pay monthly to pay off your existing loan in the time frame that you would pay off your proposed loan — the 15-year, for example. Then simply multiply the dollar amount of the accelerated payments by the number of payments. “That is your lifetime cost of the existing loan, paid off faster,” Fleming said. “Then do the same for the proposed loan and add (refinancing) costs. That is the lifetime cost of the proposed loan.” Now simply compare the two numbers. You have to move to an adjusted rate to lower your rate. With an adjustable-rate mortgage, you’ll get a very attractive, low interest rate for a set period of time — typically, anywhere from one to seven years — but, unlike a fixed-rate mortgage, your ARM rate will adjust to the going market rate after that. The problem is that interest rates are bound to go up, said Fleming.
He did add that one selling point of an ARM is that with the lower interest rate, you will pay down the principal faster, and that means the higher interest rate in the future affects you less. You’re going to sell your home within a few years. Again, refinancing costs money, so you’ll want to know that you are staying in your home for a long enough time after the refinance to recoup those costs, said Ferguson. Ideally, you’ll want to keep your refinanced loan past the break-even point; that’s when you actually start saving money.
“If you plan to move in a year or two, refinancing might not make sense, unless you are using the cash from the refinance for something that cannot wait,” Ferguson said.
One final note: This might be a time to check out an ARM, which can dramatically lower your interest rate for a few years and save you money until you sell, said Ferguson. Just make sure you will be selling before it adjusts. The long-term costs outweigh the savings. Many times, said Fleming, refinancing looks good initially, but after a little math, you discover it’s not such a great deal in the long run. “First, you’re adding years to the end of your loan. If you keep the loan for its full term, in most cases you would actually pay more for having refinanced,” Fleming said. This is because of the extra years of interest, even at a lower rate.
He suggested having a mortgage adviser calculate how much interest you’re going to pay on your existing loan over however long you believe you will keep the loan and compare it to the sum of the costs of the proposed loan and the interest cost of the proposed loan over the same period. “Make sure they look only at the interest cost and not at principal plus interest,” he said.
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