When to Refinance My Mortgage and When to Say No

If you’re a homeowner with a mortgage, you probably think about refinancing when mortgage interest rates approach rock bottom. It only makes sense. Depending on your current rate, you might be able to shave years off the loan period for around the same monthly payment as your current mortgage. Or, for a similar number of years, you might knock a hundred bucks off your payment.

When to Refinance My Mortgage

Either way, refinancing to a low rate could mean avoiding thousands of dollars in interest over the years. But that doesn’t always mean you should do it. Refinancing is not a one-size-fits-all proposition, and it doesn’t make sense for everyone. If you’re asking yourself if you should refinance, here’s when to say no.

You’re not going to stay for long

There are upfront costs associated with refinancing a mortgage. You can either pay out of pocket, or you can finance the costs, adding to your monthly payment and total interest paid.

So if it costs you, say, $2,000 upfront to close your new loan and your new rate saves you $50 per month, it will take at least 40 months to break even. If you tacked the closing costs onto the new loan amount, it might be a little more because of interest. If you were to sell the house before those 40 months are up, you will have lost money.

There’s a breakeven point for every refinanced mortgage. You must calculate that breakeven point. Then decide whether you’ll remain in the home long enough to get past it and into the black.

Your home has dropped in value

It rarely happens, but the Great Recession of 2008 showed homeowners that their properties can, indeed, fall in value, sometimes drastically. A substantial drop in a home’s value can be problematic when it comes time to refinance. In many cases, refinancing a home loan will require an appraisal. If the appraisal determines you have less than 80-percent equity in the home. You’ll either be required to contribute more cash out of pocket to close the loan or pay private mortgage insurance (PMI).

It varies between a half-percent to as much as 5 percent, but PMI usually costs 1 percent of the loan amount. So, if you borrow $100,000, you would pay $1,000 a year for PMI until you reach the point of 80-percent equity in the home. If you save $50 a month in interest but tack on $80 each month in PMI, it doesn’t make much sense to refinance.

You’re tacking on too many years

Some people refinance in order to shorten their loan period, which results in paying less interest over time. If you have 25 years left on a 30-year mortgage and can get a 15-year loan for around the same monthly payment, you’re saving 10 years’ worth of interest payments.

But if your goal is to lower your monthly payment and you sign on for another 30-year loan, you’ll wind up paying more over the long term. Mortgages are heavily front-loaded with interest, so five years into a 30-year loan, you have not really made a dent in the principal balance of your loan. You might save money now, but you will have wasted five years on mostly interest payments.

And the new loan will be the same. For another five years or so, you’ll pay mostly interest. By refinancing at this point, you’ll have lived in the home for 10 years and not really paid down your principal balance.

The bottom line

When mortgage rates drop, it’s tempting to immediately refinance your home loan. It can be a smart way to save money, but there are circumstances when it doesn’t make financial sense. It’s often a matter of simple math and timing.