Refinancing your home can provide a lot of benefits, but it's not always the best decision. Whether you're looking to refinance your mortgage to secure a lower interest rate, cash out some of your equity or switch from a variable rate to a fixed one, here are some situations where it might not make sense.
1. It Will Take Too Long to Break Even
While refinancing a mortgage could save you money in the long run, it's costly upfront. As a result, it's a good idea to run a quick break-even analysis to determine how long it'll take for you to start realizing the savings of your new loan.
For example, let's say your closing costs are $5,000, and refinancing would save you $100 per month. In this scenario, it'll take you 50 months to break even on your refinance.
If that's too long for your liking, or you don't plan on staying in the home that long, it might make sense to shop around to see if you can find better terms with another lender. Otherwise, you may want to hold off and keep the money you would've spent on closing costs.
2. You'll Pay More in the Long Run
While refinancing can help you lower your interest rate, it also typically results in extending your repayment term back to a 15-, 20- or 30-year period. Even if you're saving on a monthly basis, the extended term could result in you paying more interest overall.
This problem may only occur if you plan to stay in the home for the full loan term, so it likely won't affect most homeowners—the average homeownership tenure is 13.2 years, according to a report by Redfin. But it's still something to consider as you think about your options.
3. You Can't Afford the New Payments
If you decide to shorten your repayment term or get a cash-out mortgage refinance, your new monthly payment may end up being higher than your current one. If you can afford the new payment, that shouldn't be a problem.
However, if the new monthly payment would put too much strain on your budget or make it harder to work toward other financial goals that are important to you, refinancing might not be the right fit.
4. Your Credit Score Isn't in Great Shape
Refinancing can make sense if your credit has improved since you took out your current home loan. But if your credit score hasn't changed or it's gone down, you may not be able to access the benefits that refinancing can provide.
Anytime you're thinking about applying for credit, it's a good idea to check your credit score and credit report to see where you stand and to take steps to improve your credit, so you'll have a better chance of securing favorable terms. You should also review how refinancing affects your credit.
5. Interest Rates Are Higher
Even if your credit has improved, rising interest rates could make it more financially sound to hold on to your current loan instead of getting a new one. But if you're hoping to tap some of the equity in your home, it may make more sense to opt for a home equity loan or line of credit than a refinance.
While interest rates will also be higher for those second mortgage loans, you'll only be paying closing costs and a higher interest rate on the amount you're taking out of your equity rather than the full mortgage loan plus the cash-out portion.
Note, however, that it may still make sense to refinance so you can switch from a variable interest rate to a fixed interest rate in this situation, especially if you expect interest rates to continue to go up and you want to lock in a fixed rate to avoid rising mortgage payments.
6. You Can't Afford the Closing Costs
In general, closing costs on a mortgage refinance can range from 2% to 6% of the loan amount. If you don't have enough cash on hand to pay those costs, or you'd need to drain your savings account, leaving you without cash for emergencies, it may make sense to wait until you can better afford to refinance your home.
Many lenders will allow you to roll the closing costs into a refinance loan, but that ultimately increases your monthly payment and total interest costs over the life of the loan. Think carefully about the potential long-term ramifications of doing so before you proceed.
7. You Don't Have Enough Equity
If you're considering a cash-out refinance, many lenders only allow you to borrow up to 80% of your home's value with the new loan. If you have less than 20% equity in your home, refinancing may not even be an option. And if you only have a little more than 20% equity, you may not get enough cash out to make the process and expense worth it.
Note that some lenders may be willing to allow you to borrow up to 90% of your home's value, but going that high can increase the risk of you becoming upside down on your mortgage if home values decline in your area.
Monitor Your Credit to Help With Timing
As you try to determine the right time to refinance your mortgage loan, Experian's free credit monitoring service can help you keep track of your FICO® Score☉ and Experian credit report. You'll also get real-time alerts when your FICO® Score updates and changes are made to your credit report. If you're working to increase your credit score, the service can help you keep track of your progress and also notify you of potential issues so you can address them quickly.
