When rates fall, it can be very tempting to run out and refinance your mortgage. Did you know that it’s not always a good idea to do so, though? Below we offer tips on when you should not consider refinancing.
Closing Costs are too High
Every time you refinance you pay closing costs. If you don’t pay them because you have a ‘no closing cost loan,’ you pay them in the higher interest rate. One way or the other, you are paying the bank because they don’t write loans for free.
Just because you pay closing costs isn’t a reason to consider refinancing. What is, though, is when the costs are so high that your break-even point is many years down the road. While there isn’t a specific number everyone aims for, typically a break-even point longer than 5 years is too much.
You can figure out your break-even period by figuring out your monthly savings with the new loan. Let’s say you’ll save $150 per month by refinancing. You then divide the total closing costs by your monthly savings. Let’s say your closing costs are $4,000. Your break-even period would be 27 months. After 27 months, you would start realizing the savings from the new loan.
The Term Would Extend
When you refinance you start the term all over again. If you have a 30-year term now, but paid on it for five years already, you only have 25 years left. Refinancing right now into another 30-year loan would be that five years right back on the term.
Adding five years back on the term is bad enough, but now you are back to paying mostly interest for the first few years of the term. If you want the new loan because you can lower your interest rate, that’s one thing, but consider trying to get a lower term. In this case, even a 25-year term would be good. You’d save money on your payment yet leave the remaining years on the mortgage the same.
You Need to Roll the Closing Costs Into the Loan
Closing costs can really add up. If you don’t have the cash to pay them out of your own pocket, don’t refinance. Again, the no-closing cost loan really doesn’t mean no closing costs. Instead, you’ll pay at least 0.5% higher interest. This actually turns out to be more by the end of the term. For example, let’s say you have a $100,000 loan on a 30-year term. If you pay the closing costs you could have a 4% interest rate. If you take the no-closing cost loan, you’d have a 4.5% rate. Here’s how it works out:
- 0% = $477 monthly payment
- 5% = $507 monthly payment
That’s a difference of $30 per month. Over the course of 30 years, that means $10,800 more for the slightly higher rate. This was all to save a few thousand dollars on closing costs.
If you opt to roll your closing costs into the loan, it’s even worse. You pay interest on that amount, which means the few thousand dollar closing costs could cost you closer to $10,000 by the end of the term.
You Can’t Afford Your Debts
It’s easy to think you can roll your debts into your mortgage and make life easier for yourself. This is especially enticing if you can’t afford your debt payments right now. But, it’s a double-edged sword. Think about why you are in so much debt. Are you a spender? Will you use your credit cards again once they have available credit again?
Let’s say you wipe out your credit card debt of $20,000, wrapping it into your mortgage. That means you just lost $20,000 of your home’s equity. That credit card debt which was once unsecured is now secured by your home. If you default, you could lose your home. To make matters worse, you have the credit available now. If you are not disciplined enough to put the cards away and never use them, don’t refinance your debt into the mortgage. It only sets you up for even more financial ruin.
Refinancing can be a good thing. It can save you money, lower your interest rate, or lower your term. But, you have to do it right. Think about the big picture. Are you actually saving after you pay your closing costs? Are the savings great enough? Are you trying to get yourself out of debt, but are unsure if you can leave your credit cards alone? These are the questions you must ask yourself to determine if you should leave your mortgage loan or take advantage of the lower rates/terms that are available.