Even with falling interest rates, a refinance may not be the best move.
A mortgage refinance is when you take out a new home loan to pay off and replace your old loan. Common reasons to refinance are to lower the monthly interest rate, lower the mortgage payment, or to borrow additional money.
When mortgage rates are falling, it might seem like a good time to refinance your home — to lower your loan payments or tap into some of the equity you’ve built up.
But while refinancing can be the right choice, keep in mind that trading your existing home loan for a new one isn’t always the best solution. Here are a few scenarios when a refinance might not be a good idea.
1. You’ve had your mortgage for a long time
The proportion of your mortgage payment that is credited to the principal of your loan increases each year, while the proportion credited to the interest decreases each year. So, in the later years of your mortgage, more of your payment applies to principal and helps build equity.
By refinancing late in your current mortgage, you will restart the amortization process, and most of your monthly payment will be credited to paying interest again and not to building equity.
If you decide a refinance is in your best interest, ask about a “flexible term mortgage.” You can set a mortgage for 10, 12, 15, 17 years, or anything in between. You don’t necessarily have to reset your term at 15 or 30 years.
2. Your current mortgage has a hefty prepayment penalty
Although uncommon these days, a prepayment penalty is a fee that lenders might charge if you pay off your mortgage early — including for refinancing. If you’re refinancing with the same lender, ask whether the prepayment penalty can be waived. You should carefully consider the costs of any prepayment penalty against the savings you expect to gain from refinancing.
If your loan has a prepayment penalty, it’s likely you also have a higher interest rate that you you would like to lower. An experienced loan officer can help you analyze cost versus savings, and in some cases help you time your refinance appropriately to avoid the penalty all together.
3. You plan to move in the next few years
The monthly savings gained from lower monthly payments may not exceed the costs of refinancing. If you are planning to move in the near future, a break-even calculation will help you determine whether it is worthwhile to refinance.
For example, if you’re going to save $200 a month but will have to pay closing costs of $4,000, you’ll need to stay in the home for more than 20 months to come out ahead. A good loan officer can help you with this calculation, and help you determine whether a refinance makes sense based on your future plans.
What about credit card debt?
For some situations, paying off high-interest credit card debt with low-interest mortgage debt can be a good strategy. To wipe out your credit card balances, you’ll need to do what’s called a cash-out refinance: You borrow more than you owe on your home and take out the extra in cash. That money goes to your card issuer. You’ll be left with a larger mortgage and larger monthly payment. However, you need to be absolutely certain you’ve conquered your reliance on plastic. If you get in over your head with your credit cards all over again, you could put your house at risk.
4. You want to invest in stocks and bonds
Investing in stocks, bonds and other assets can be a great way to build long-term wealth, but it’s very risky to invest with equity pulled from your home in a cash-out refinance. For the modest earnings on “safe” investments like certificates of deposit, refinancing is hardly worth the effort. And the more lucrative investments can involve considerable risk: You could lose your money and be left with nothing but a bigger mortgage.
5. You’re tempted by a “no-cost” refinance
All mortgages come with fees and other costs that have to be paid. So, be skeptical when a lender claims to offer a “no-cost” or “low-cost” refinance. These heavily-marketed loans hide all the closing costs — The fees may be rolled into your loan amount, or be passed on to you in the form of a higher interest rate. Learn more