Refinancing a mortgage can be a great way to save money. After all, a mortgage payment is many people’s largest monthly expense. If you can reduce the amount you’re paying a mortgage lender every month, that will leave more money in your bank account for other financial goals.
But while refinancing can be a good financial move, it’s not the right choice in every situation. In fact, here are a few circumstances where refinancing your mortgage would make no sense at all.
1. If you can’t qualify for a refinance loan at a lower rate
In almost every situation, the point of refinancing is to make your new loan cheaper than your old one. If you cannot qualify for a new loan at a lower rate, then refinancing would have the opposite effect. You don’t want to get a new loan just to pay your new lender more than your old one, so pass up on refinancing if that’s the case for you.
This will likely mean it makes no sense for anyone who got a mortgage a few years ago to refinance any time soon. Mortgage rates hit record lows during the height of COVID-19 and have been at recent-record highs in the last year or so.
2. If you will be moving soon
It likely makes no sense to refinance if you’re going to be selling your home soon. That’s because there are usually upfront costs of getting a refinance loan. You could pay anywhere from 2% to 5% of the loan amount in refinance closing costs. It will take time for your new lower payments to make up for that.
Say, for example, you originally borrowed $300,000 at 7.25% in 2022 and you’re considering refinancing into a new 30-year loan at 6.70% — but your new loan comes with $9,000 in closing costs (3% of the amount you’re borrowing).
While you’d save $150 a month in payments, the upfront closing costs you’d pay would mean it would take you over five years to break even. You’d end up paying $1,303 more for your loan during those first five years, even after accounting for the fact you will pay down your principal a little faster with the loan at the lower rate.
If you’re moving any time within the coming few years, you need to take closing costs into account when deciding how much getting a new refinance loan would actually save you. For a quick rule of thumb, divide the amount you’ll pay in closing costs by the amount you’ll save monthly to see how long it would be before you’d break even on those closing expenses. Or you can use online refinancing calculators that give you specific details of how long it would take to break even, if you want to be sure.
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3. If your current loan is almost paid off
Finally, refinancing likely doesn’t make sense if your current loan is almost paid off. That’s partly because you may not have the new loan long enough to make up for the closing costs. Taking out a new loan when you’re close to being done would also reset the clock on your payments.
Say, for example, you had five years left on your loan but refinanced to a new 30-year mortgage. You’d lower your payments a lot since you’d be taking 30 years to pay off the remaining debt instead of five, so each payment could be much smaller. But the extra years of interest tacked on would ultimately make payoff much costlier.
The bottom line is, refinancing can make sense if you can lower your rate enough to cover closing costs in a reasonable time and if you’re staying put for a while. Otherwise, you’d be better off sticking with the loan you’ve got.
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