When interest rates dip or your financial situation changes, refinancing your mortgage might seem like a no-brainer.
Who wouldn’t want to lower their monthly payment or cash out some equity? But here’s the truth – refinancing isn’t always the smart move.
While it can offer benefits in the right situation, refinancing also comes with real risks, hidden costs, and long-term tradeoffs that many homeowners overlook.
From high closing fees to unfavorable interest rates, the wrong refi at the wrong time can end up costing you more than you save.
Before you jump into a new loan or get excited about a lower rate, take a moment to weigh the downsides. In this article, we’re breaking down six reasons why refinancing your mortgage might not be the right choice – especially in today’s changing market.
If you’re thinking about making a move, read this first. It could save you thousands.
6 Reasons Refinancing Your Mortgage is Not a Good Idea
1. Takes Longer to Break Even
Although you could end up saving money by refinancing your mortgage, the process is expensive up front. So, it’s a good idea to perform a fast break-even analysis to identify when you will be able to actually see the savings from your new loan amount.
Let’s imagine your closing cost fees (More on these in #5) were $5,000 and that you would save $100 a month by refinancing. In this case, it will take 50 months for your remortgage to pay for itself.
If you don’t want to wait that long or don’t expect to live in the house that long, it could make sense to shop around to see if another lender can offer you better terms. If not, you might wish to wait and save the cash you would have paid on closing expenses.
2. More Expensive in the Long Run
While refinancing can decrease your interest rate, it usually causes your payback term to be increased to a 15-, 20-, or 30-year period. Even though you save money each month, the longer term may cause you to pay more interest altogether.
The average length of homeownership in the US is 8 years, so this issue probably won’t affect most homeowners. This issue may only arise if you want to remain in the property for the whole loan term.
However, while you explore your alternatives, it’s still something to take into account.
In addition, you may not be able to afford the new payments. Your new monthly payment can wind up being greater than your current one if you want to reduce your repayment period or obtain a cash-out mortgage refinancing.
3. When Your Credit Score Isn’t Looking Good
If your credit score has improved since you took out your existing mortgage, refinancing may make sense.
However, if your credit score hasn’t changed or has decreased, you might not be able to take advantage of the perks that refinancing can offer.
It’s always a good idea to check your credit score and credit report if you’re considering asking for credit to determine where you stand and to take actions to improve your credit so you’ll have a greater chance of obtaining favorable conditions.
4. Interest Rates are Higher
Even if your credit has improved, it could be more beneficial financially to stick with your current loan rather than applying for a new one if interest rates have gone up.
If you bought a home in early 2021, you may have enjoyed the incredibly low mortgage interest rates of 2.65% – 3.09%. But times have changed, and if you find yourself refinancing now, the average has gone up to just under 7%. That’s a huge difference in payments.
In this case, it might not make sense to refinance.
But, if your goal is to secure more funds to do a big renovation, buy a new car or boost your education, looking to a home equity loan may be a better option for you.
Home equity is the amount of your home that you actually own. It’s the difference between how much your home is worth and how much you still owe on your mortgage.
For example, if your home is worth $450,000 and you still owe $250,000 on it, your home equity is $200,000.
A home equity loan lets you borrow money using that $200,000 as collateral. It works kind of like a second mortgage—you get a lump sum of cash, and then pay it back over time with a fixed interest rate (usually over 10 to 15 years). The current US average interest rate for Home Equity Loans is 8.37%.
Although the interest rates on these loans will also be higher, you will only have to pay closing costs plus the higher interest rate on the amount you are taking out of your equity as opposed to the complete mortgage loan plus the cash-out part.
However, keep in mind that it might still be advantageous to refinance in this scenario so you can change from a variable interest rate to a fixed interest rate, particularly if you anticipate that interest rates will continue to rise and you want to lock in a fixed rate to prevent rising mortgage payments.
Comparing Home Equity Loans vs HELOC: Which is Better For You?
5. You Can’t Afford the Closing Costs
Closing expenses for a mortgage refinancing typically run between 2% and 6% of the loan amount.
So, if you’re refinancing a $175,000 mortgage, you could end up paying between $3,500 – $10,500 in closing cost fees.
Typically, closing costs include fees for attorneys, credit checks, appraisals and surveys.
Waiting until refinancing your house is more affordable may make sense if you can’t cover those payments or would have to dip into your savings, which would leave you without cash for emergencies.
The closing expenses can sometimes be rolled into a refinancing loan by many lenders, but doing so eventually raises your monthly payment and overall interest charges over the course of the loan. Before you act, carefully consider any potential long-term repercussions.
6. You Don’t Have Enough Equity
Many lenders only let you borrow up to 80% of your home’s worth with the new loan if you’re thinking about a cash-out refinancing.
Refinancing could not even be a possibility if your home’s equity is less than 20%. Additionally, if your ownership is only a little bit higher than 20%, you would not receive enough money to justify the procedure and associated costs.
It should be noted that while some lenders could be ready to let you borrow up to 90% of the value of your property, doing so raises the possibility that you could end up upside down on your mortgage if home prices in your neighborhood decrease.
Final Thoughts
Refinancing can be beneficial or detrimental, but there is no hard and fast rule.
It all depends on your financial situation. Many homeowners find that refinancing their mortgages is a smart financial decision, especially if they want more assistance than what mortgage relief can offer.
However, not every refinance is a good idea. Whether it’s a good idea or a bad idea just depends on what’s right for you. Before choosing, make sure to consider all your possibilities.
Editor’s note: This article was originally published Dec 31, 2022 and has been updated to reflect market changes.
