Refinancing has become a popular choice for homeowners in 2020 as interest rates are at all-time lows. You may hear about the refinancing from friends or family and wonder if you should do the same.
While refinancing can be an effective way to lower your mortgage interest rate or lower your monthly payment, there are some situations when refinancing could be a bad idea. Once you’ve thought about it, keep these situations in mind and consider whether refinancing is really the right financial move for you.
Is it worth refinancing?
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 with a new lender. You are probably wondering why people do this.
When is it worthwhile to refinance your mortgage?
One of the most popular reasons to refinance is to lower the mortgage rate. Interest rates in 2020 are historically low and many people are taking advantage of this to secure lower interest rates on their mortgages.
Someone could also refinance a mortgage to lower their monthly payments. If your financial situation has changed and your current mortgage payment is no longer affordable, refinancing and extending the loan term can reduce your monthly installment.
Other reasons to refinance could include removing the PMI when you have increased your equity in your home, changing your loan type (switching from a floating to a fixed rate or vice versa), or accessing cash with a withdrawal refinancing.
[ 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 times when it just doesn’t make sense.
Refinancing your mortgage comes with many additional costs, both in the short and long term. Refinancing doesn’t save you money right away. Due to the cost of closing, it will likely take years to break even. If you extend the term of your mortgage or refinance yourself when you have little equity in the house, interest and personal mortgage insurance can also be expensive.
As with any other mortgage closing, you will need to pay the closing costs to complete your refinance. Closing costs can average anywhere from 2% to 5% of your loan amount – or anywhere from thousands to tens of thousands of dollars.
Typical closing costs are:
- Loan application fee
- Appraisal fee
- Inspection fee
- Origination fee
- Legal fees
In most cases, the closing costs are due when the final loan documents are signed. If you are thinking of refinancing to get more cash in your pocket, you should be aware that it can take years to break even.
Long term costs
In addition to the closing costs you have to pay, there are other costs for refinancing your mortgage. First, you can actually pay more interest in the long run. Let’s say you have a 30 year mortgage that is currently 15 years amortization. You have already paid a substantial amount of interest.
Now let’s say you decide to refinance into a new 30 year mortgage. The lower refinance rate may not help you in this case as you have doubled the time it takes to pay off your mortgage.
Refinancing can also be expensive if you have less than 20% equity in your home. If so, you will likely have to pay for personal mortgage insurance (PMI) for many years. So it may be worth waiting until you have more equity in your home.
Your credit score needs to be improved
Your credit rating is one of the most important factors in deciding whether you can get a refinancing loan. Even if you qualify for a loan with a bad rating, you are unlikely to get the best interest rates. At this point, refinancing may no longer be worthwhile.
If your credit score needs improving, you will likely be better off spending some time improving your score. There are several ways you can improve your creditworthiness:
- Make all of your monthly payments on time
- Reduce your credit utilization, either by paying off debt or increasing your available credit
- Find any disputes or errors in your credit report
You are not there forever
Because of the additional costs, it can take years for your refinancing to balance. If you don’t want to stay home long enough to take advantage of the lower interest rate, refinancing may not be the best option for you.
Do some numbers and figure out how long you would have to be inside the house to save money – and then decide if you can commit to staying that long.
To find out how long it will take to clear your refinance, divide your closing costs by your total monthly savings. You can also use a mortgage refinancing break-even calculator to make the calculation easier.
Are you considering refinancing your mortgage? Here are a few tips to follow to get started.
[ Read: How to Refinance Your Mortgage ]
Decide why you want to refinance.
Are you refinancing in hopes of a lower interest rate? Or is your goal to lower your monthly payment? Get into the process and know why you really want to refinance. This way you know exactly what type of loan offer you need to make refinancing worthwhile.
Shop around for the best prices.
There are many options for mortgage lenders between traditional banks, credit unions, and online lenders. Spend some time browsing to make sure you are getting the best price.
Check out your credit report beforehand.
The last thing you want is to apply for a refinance loan and find an unwelcome surprise on your credit report that may prevent you from getting a good deal. Get your credit report ahead of time so you know what to expect.
Do the math and decide whether it’s worth it.
Depending on the type of deal you can get for your refinance, it might not always be worth it. While you might get a lower interest rate, the other expenses associated with it can mean you still pay more over time. Do the math to make sure you meet your ultimate refinancing goal.
Compare the best mortgage lenders
Too long not read?
Refinancing your mortgage can be an effective way to lower your monthly payments and save money. However, every situation is unique and there will be times when refinancing is simply not worthwhile due to the additional costs. If you find yourself in any of the above situations, you may want to question this refinancing.
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