There are a lot of good reasons to refinance your mortgage, especially with rates as low as they are. But at the same time, there can be some pretty good reasons not to refinance as well.
Many borrowers get so focused on the possibility of saving money that they neglect to consider the potential downsides of refinancing. But they definitely exist, and you want to take them into consideration before taking the plunge.
Here are five of the main reasons not to refinance your mortgage, or at least, not to refinance quite yet.
1. You won't be in the home long enough
A big consideration in refinancing is the "break-even point," the point when your savings from refinancing exceed your closing costs for the loan. Since closing costs on a refinance typically range from about 2-4 percent of the loan balance, it's going to take a few years to recoup that from a savings of half a percent on your loan.
Think about it: If you pay $4,000 to refinance a $200,000 mortgage and your half-percent reduction only saves you $60 a month, it's going to take you 66 months -- five and a half years -- to break even. And that's with only 2 percent in closing costs. If your closing costs were percent closing costs, it would take you more than eight years. So if you're planning to move before then, it's just not worth it.
2. Closing costs too high
This is pretty similar to #1. You may have a chance to significantly reduce your mortgage rate, or perhaps pay your loan off faster, but the closing costs are too high for you to pay out of pocket. You might be able to roll them into the loan amount, but that might boost your payments enough to make refinancing less attractive.
As mentioned above, the cost to refinance a mortgage usually runs from 2-4 percent of the loan amount, sometimes even more, particularly if you buy discount points. If you roll that into the loan amount, that's adding thousands of dollars onto your mortgage, reducing your home equity. Otherwise, it's money right out of your pocket. You have to decide if the eventual savings or shorter loan term is worth it.
3. Damaged credit
If your credit is less than ideal -- say, a FICO score in the upper 600s -- you may find that while you can find a lender who will refinance your mortgage, the interest rate you can get is much less attractive than what's being offered to borrowers with higher credit scores.
In the current mortgage environment, the temptation can be strong to just bite the bullet and take the rate you can get. After all, mortgage rates are incredibly low right now and you don't want to miss out on that, even if you're not getting the best rate possible.
However, unless you have a major blemish on your credit like a bankruptcy, default or seriously delinquent loan (more than 90 days past due), you may be able to improve your credit faster than you think. Most of the effects of minor credit infractions fall off your report within two years, so you may be able to get a better rate then. The Fed has indicated it wants to keep rates low through at least 2015, so if you're in this situation, waiting to refinance is something you may want to consider.
4. Shortening your term too much
With rates on 15-year mortgages as low as they are, there's a great temptation for many borrowers to try to cram what's left of a 30-year mortgage into a 15-year payoff. While this can save a ton of money over the long term, it can also cause some pretty heavy financial stress in the meantime.
Paying an extra couple hundred dollars a month more may not seem like much, but you're going to be doing that for 15 years -- and you can't scale it back if you hit a tight spot. What are your finances like currently? Can you spare that much cash every month on a long-term basis? You want to make sure the answer is yes before you go about shortening up your mortgage term too much.
5. Extending your term
Lengthening the term of your mortgage is another possibility. Since the "standard" residential mortgage is a 30-year fixed-rate loan, it's very easy to simply refinance back into one of those, even if you've already paid off five years or more of your old one. You get a reduced rate and because the loan amount is smaller than the original mortgage, you can see a hefty reduction in your monthly payment.
The problem is that this can cost you over the long term. Yes, you're reducing your monthly payment, but you're also extending the time it will take to pay off the loan. That longer term also means that much of your savings can get eaten up by compounded interest.
A better approach is to take out a 30-year loan but ask your loan officer to set your payments on a schedule where you'll still pay it off in 25 years or however much time is left on your current mortgage. That way, you'll still get a nice reduction in your mortgage payments but will still keep your original payoff date.
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