When Not to Refinance Your Mortgage

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Point of Interest

Refinancing your home could be a way to reduce monthly repayments or lower your internet rate. In many cases, though, there are legitimate reasons why refinancing is a bad idea and could end up costing more than any savings are worth.

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Refinancing your home is the process of taking out a new loan to pay off your original mortgage. There are several reasons a homeowner may want to do this, but there are also a few downsides to be aware of, too. The costs could outweigh the benefits in many cases, so it’s wise to do your research before refinancing and find out some of the reasons why you shouldn’t refinance your home. You may find that refinancing your home is not worth the money or the hassle.

6 reasons not to refinance your mortgage

One of the main reasons for refinancing is that it can result in lower interest rates and monthly payments. However, if you refinance and extend the loan’s term, you will typically have to pay back more in interest over the life of the loan, and the closing costs of refinancing a home also need to be taken into account.

There are several other reasons that you may want to avoid refinancing your mortgage, including:

1. Your credit score is poor.

How good your credit score is can have a huge effect on whether refinancing is worth the money and the time spent to do it. If you have a good credit score, you may get a better rate on your new loan. However, if your credit score is poor, you may struggle to find a lender willing to help you refinance at any interest rate. This is because lenders will view you as a higher risk. This can happen even if the average mortgage interest rates are low.

In this case, any savings you make on your monthly costs could be minimal. This means it will take you longer to break even on the closing costs. Therefore, it may be wise to hold off on refinancing even if interest rates are low.

2. You can’t afford the closing costs.

Refinancing your home is essentially like taking out another mortgage and with it comes new closing costs for the new loan. The closing costs when taking out a new mortgage can range from 2% to 5% of your home’s purchase price on average.

While refinancing can result in lower monthly repayments, you need to make sure the closing costs do not outweigh the benefits. A good rule of thumb is to work out how many months it would take you to break even on your closing costs and then do the math to see if you plan to stay in your home that long. If you have plans to sell in the future, you may want to think twice about your refinance.

If you do not have the money on hand to pay the closing costs upfront, you may be able to roll them into your monthly mortgage repayments. However, this makes your monthly repayments higher and will cost you quite a bit more in interest over the long haul. If those higher repayments result in you paying more than you save from refinancing, you could end up in a worse position than you were prior.

3. You want to use your home’s equity.

Tapping into your home’s equity can sometimes be a smart move. For example, you could finance home improvements by refinancing and borrowing against the equity in your home, which increase the value of the property post-improvements.

However, using a home equity loan could affect any savings you get from refinancing your property. If you tap into home equity while refinancing, you’ll end up paying interest on both the new loan and any money you borrow from the equity in your home. Plus, you ideally want to retain as much equity in your home as possible, and borrowing against the portion of the home that you’ve paid off will cut down on that, sometimes significantly.

4. You are not planning to remain in the home for very long.

With closing costs averaging between 2% to 5%, it could take several years for you to break even on them — even if you refinance at a much lower interest rate. If you are planning to move home in the near future, refinancing makes little sense, as any savings benefit from the lower rate will be negated by the high closing costs you paid to refinance.

For example, if your closing costs are $2,000 and your refinance drops your monthly payment by $50 a month, it will take you 40 months to break even on the closing costs. Is refinancing bad in this case? Well, it is if you plan to move before those 40 months are up because you’ll have paid more in closing costs than you saved.

5. Higher long-term costs

Mortgage loans front-load the interest costs, so for the first several years of the loan you’ll be paying more in interest charges than you are on the principal. If you have already been paying your existing loan for a number of years, you may have paid down the interest enough that your monthly payments are making a dent in the principal you owe.

If you were to refinance to a longer 30-year mortgage, you will have a lower monthly repayment, but the first several years of your loan will be spent paying down the interest portion of the loan first. This will cost you a lot more in the long run because it will cut down on how much of the principal you’re paying off with your monthly payments.

6. You recently purchased your home.

Some people are tempted to refinance as soon as they see interest rates dip. In some cases, refinancing in the event of lower interest rates can lead to significant savings. However, if you have recently purchased your home with a conventional loan and do not have a ton of equity built up from a large down payment, it is probably not advisable to refinance. Most lenders want you to have at least 20% equity in your home for a conventional refinance loan.

If you have a large amount of equity in your home, you could benefit from refinancing because you will have a lower loan-to-value ratio (LTV). This means that banks see the loan as less risky and will typically allow you to refinance. However, if you have recently purchased your home, you are unlikely to have high equity — unless you made a significant down payment when purchasing the home.

The final word

Is refinancing a bad idea? In some cases, it can be a smart move that results in lower monthly repayments and less interest paid over time. However, the costs need to be calculated to ensure that refinancing is worth it long-term.

There are many reasons why you shouldn’t refinance your home. Whether or not it’s right for you depends on your circumstances, credit score, interest rates and equity. Just because interest rates are lower does not necessarily mean you will save money with a refinance. The numbers need to line up before you make your move.

Kara Copple

Contributing Finance Writer

Kara is a freelance writer, specializing in personal and business finance content. She loves taking complex topics and making them easier to understand to help people improve their knowledge on all things finance-related.