When is mortgage refinancing not a good idea?

by Advisor Voices
Mortgage Refinance, Mortgages,
When is mortgage refinancing not a good idea?

Why people Refinancing their Home loan? Typically people refinance their mortgage rate in order to take advantage of lower mortgage rates. But there is some times When is mortgage refinancing not a good idea.

Reason #1 – You’ve had your mortgage for a long time.

The amortization chart shows that the proportion of your payment that is credited to the principal of your loan increases each year, while the proportion credited to the interest decreases each year. In the later years of your mortgage, more of your payment applies to principal and helps build equity. By refinancing late in your 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.

Amortization of a $200,000 loan for 30 years at 5.9%
amortization_chart

Reason #2 – Your current mortgage has a prepayment penalty

A prepayment penalty is a fee that lenders might charge if you pay off your mortgage loan early, including for refinancing. If you are 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. Paying a prepayment penalty will increase the time it will take to break even, when you account for the costs of the refinance and the monthly savings you expect to gain.

Reason #3 – You plan to move from your home in the next few years.

The monthly savings gained from lower monthly payments may not exceed the costs of refinancing–a break-even calculation will help you determine whether it is worthwhile to refinance, if you are planning to move in the near future.

It’s not always great to refinance.

Here are some considerations to keep in mind:

  1. If you don’t think you’ll stay in your home long enough to recoup the closing costs for the refinancing (yes, there are closing costs the process is very much like getting your initial mortgage), then don’t refinance. If your closing costs are $2,500 and you’ll be enjoying monthly payments that are $100 lower, then it will take you 25 months to break even so that the refinancing was worth it.
  2. If you won’t be able to reduce your loan’s interest rate by about one percentage point, going through the trouble of refinancing may not be worth it. Online calculators can help you crunch the numbers to decide.
  3. If you’re refinancing to take out some of your home equity, think twice. You’ll often end up with a bigger loan balance than you had before refinancing, and less equity in your home, too. In exchange for that, you did receive a chunk of change, but if you used it to remodel a kitchen or buy a new car, you probably won’t come out ahead, financially. The car will start depreciating immediately, and most remodelings don’t net you more when you sell the home as you paid for them. Only cash out if you really need the money. Every dollar you borrow with your mortgage will probably take a long time to get paid off, costing a lot in interest.
  4. If you’re refinancing to lower your payments by lengthening the life of your loan (perhaps by going from a 15-year loan to a 30-year one), be sure that you’re OK with paying thousands more in interest and being in debt much longer. You might mitigate the downside of this move by enjoying lower payments but making a few extra ones throughout the year, which can reduce the life of your loan and save a lot in interest. Just be sure that your new loan permits prepayments.
  5. If you’re refinancing to consolidate debt, perhaps because you’d like to pay off high-interest-rate credit card debt with low-interest mortgage debt, think twice. It can be an effective strategy, but if you’re saddled with credit card debt because you tend to spend beyond your means, then you’re not likely to suddenly change your ways. You’ll instead be taking on more long-term debt, while feeling unburdened by credit card debt and perhaps feeling freer to spend beyond your means again.

The bottom line

There are many considerations when you’re thinking about refinancing a mortgage. Think through them all, and you can save a lot of money.

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