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When and why to refinance is a question a lot of people have, especially with the way interest rates are going up these days. It might seem tempting to try and grab a lower rate to save some cash each month, but there are actually a range of situations where refinancing could end up doing more harm than good. This article covers when and why refinancing might be a bad idea and the key questions you need to ask yourself before taking the plunge.
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Don’t Fall For The Hype. Here’s When Refinancing Is Actually a Bad Idea
Before diving into the details, remember that every financial situation is unique. What works for your neighbor might not work for you. But there are a few universal red flags that scream “STOP.” when it comes to refinancing. If you see any of these, it’s time to take a step back and seriously reconsider.
1. Closing Costs Eat Up Your Savings
Everyone talks about snagging lower interest rates with refinancing, but they conveniently forget about closing costs. You could be hit with a number of fees that include things like appraisals, title searches, and origination fees.
Some experts recommend factoring in around $5,000 for closing costs. To figure out if you’re actually coming out ahead, calculate how long it’ll take for those monthly savings to make up for those initial expenses. If you are planning on moving soon, you may not recoup the closing costs. Talking to a mortgage broker or financial expert is always a good idea as a starting point.
2. Your Credit Score Takes A Hit
This one often flies under the radar. Did you know every time a lender checks your credit during the refinance process it shows up as a hard inquiry?
Hard inquiries temporarily lower your credit score, which is the opposite of what you want, especially if you have any other big financial plans on the horizon. A lower credit score could mean you won’t get approved for new credit cards, or if you do, they may come with a higher interest rate. Make sure you check your score beforehand to ensure it is at its best so you qualify for the best refinance rates possible.
3. You’re Planning To Move Soon
If you’re itching to relocate in the next couple of years, refinancing might not be your best friend. Again, remember those closing costs? It usually takes a couple of years to break even after those expenses, so a short-term move might make it so that refinancing isn’t actually financially worth it for you.
4. You’re Stretching Out the Loan Term
Sure, getting a 30-year mortgage might lower your monthly payments. Almost 90% of Americans choose a 30-year loan term because their monthly payments are much less than with a shorter-term mortgage, like a 15-year. But here’s where things get sneaky. That sweet deal you get with a 30-year often means you’re shelling out way more in total interest over the long haul.
Crunch the numbers with a mortgage calculator and be brutally honest with yourself about how long you actually plan to stay in the home. Extending your loan term means making more mortgage payments, which means paying more interest. Are you extending the mortgage unnecessarily or delaying reaching that magical “mortgage-free” milestone by taking on an even longer loan term?
5. You Don’t Have Enough Home Equity
Most lenders want to see a solid amount of home equity before even looking at your application, with many requiring around at least 20% for you to qualify for good rates. Your home equity is the difference between what your home is worth and what you still owe on your mortgage.
If your home equity isn’t that high, you’re basically fighting an uphill battle to find lenders who’ll even entertain the idea, or you’ll end up with a cash-out refinance that is not a very good deal for you. If you are thinking of refinancing, you should also know the difference between an adjustable-rate mortgage and a fixed-rate mortgage. When interest rates are low, a fixed-rate mortgage will provide more stability.
FAQs about When And Why Refinancing Might Be A Bad Idea
FAQ 1: Why is refinancing a bad idea?
Refinancing is not always a smart financial move because of high closing costs, extending the loan term, or decreasing your credit score, even if temporarily. For example, refinancing to consolidate debt by paying off your credit card will not help if you run those credit cards right back up.
FAQ 2: When should I not refinance?
When refinancing might be a bad idea for you is when your credit score isn’t high enough to qualify for a great interest rate, you can’t or don’t want to make a big down payment, or the closing costs for your new mortgage are more than your current mortgage costs. Refinancing may not be a good fit if you plan on selling your home before you recoup your refinance costs or your debt-to-income ratio is too high.
FAQ 3: Why would someone not want to refinance?
One of the biggest reasons someone would not want to refinance is that they may be moving soon. Refinancing usually means spending thousands in closing costs. You need to calculate whether you will live in your home long enough to recoup your refinancing costs.
FAQ 4: What should you not do when refinancing?
When and why refinancing might be a bad idea goes back to ensuring your credit is good and debt is manageable. If you are considering a mortgage refinance, you may also be tempted to get a cash-out refinance to do things like home improvements. Refinancing to extend your loan term to get a smaller monthly payment is also usually not recommended, unless there are very compelling extenuating circumstances. But always do your research.
We’ve outlined a lot of the reasons when and why refinancing might be a bad idea. Deciding whether or not to refinance is personal. It’s best to be cautious because it involves a lot of time, paperwork, money, and other costs. Weigh the pros and cons carefully and don’t be afraid to say “no” to refinancing if it doesn’t make sense for your situation.
