3 Times When Refinancing Doesn’t Make Sense (And 3 Times When It Does)

Believe it or not, refinancing is not always a smart financial decision. In order to help you get a better idea of whether or not refinancing makes sense for you, we’ve laid out some scenarios for you below. Keep reading to learn about three times when refinancing doesn’t make sense and three times when it does. Armed with this knowledge, you should have a much better idea of whether or not it makes sense to talk to a lender about your refinancing options.

3 times when refinancing doesn’t make sense

1. You won’t get a low enough interest rate.

Whenever interest rates go down, many homeowners think about refinancing. However, the truth is that when you’re thinking of refinancing, you can’t just look at today’s interest rates. You also have to look at the rate you have on your existing mortgage.

As a rule of thumb, if you can’t lower your interest rate by at least one full percentage point, you won’t save enough to make refinancing make sense. At that point, it is better to wait until rates are lower to refinance or to simply make extra principal payments on your existing mortgage in order to pay it down faster and save on interest charges.

2. You’re planning on moving soon.

When you’re thinking about refinancing, you also need to factor in your closing costs. Put simply, closing on a new loan costs money, so it may take you a while to break even on your refinance. You can calculate your break-even point by dividing your total mortgage closing costs by the amount that you stand to save on each monthly payment from refinancing.

For example, if your closing costs equal $6,000 and you save $200 on each monthly payment after refinancing, it will take you 30 months, or 2.5 years, to break even on the cost of your refinance.

If you plan on moving to a new home before you hit your break-even point, it doesn’t make sense to refinance. In that case, you would be spending more money than you would be saving.

3. You’ll face a pre-payment penalty.

Last but not least, you may not want to refinance if your mortgage is subject to a pre-payment penalty. In this case, you have to remember that refinancing is essentially paying off your old loan and replacing it with a new one. That action would trigger the pre-payment penalty and you would have to pay a substantial fee.

Although pre-payment penalties are no longer allowed to be included in newer mortgages, if you’ve owned your home for a while, it could be an issue. With that in mind, if you think you might be subject to this type of fee, the best bet is to talk to your lender. They can tell you about the conditions of your loan and help give you a sense of your options.

3 times when refinancing does make sense

1. Your credit has significantly improved.

If your credit has improved greatly since you first applied for a loan, it may be worth looking into refinancing. Here, it’s important to note that your credit score is often the thing that defines the interest rate that you will be given. There’s a distinct possibility that you weren’t given the best interest rate the first time around. However, since your credit has improved, you may be able to score a much lower rate.

2. You want a more stable payment.

If you originally took out an adjustable-rate loan and you have exited your introductory rate period, you may be looking to refinance into a fixed-rate loan. While interest rates may be slightly higher on fixed-rate loans, they offer the stability of a monthly payment that stays the same, which can allow you to better budget your finances. Plus, while interest rates are historically low, you may be able to get a rate that is similar to the adjustable-rate offerings.

3. You need cash to cover a big expense.

Lastly, if you need cash to cover a big expense like education costs or medical debt, you may want to consider doing a cash-out refinance. A cash-out refinance allows you to borrow against the equity that you’ve built up in your home. In this case, you borrow more money than you currently owe on the home and keep the difference in cash. You can use that money however you see fit.

The bottom line on refinancing

At the end of the day, the decision to refinance your home it’s a big one. Refinancing costs money and also typically adds years to the amount of time you will spend paying your mortgage. To that end, it’s important to make sure that refinancing makes sense before undergoing this process. Use the scenarios in this post as a guide when making this decision. However, if you have more specific questions, it may be a good idea to reach out to a financial advisor.