When Refinancing is Not the Best Option

When Refinancing is Not the Best Option

The steps that the Federal Reserve has taken to help increase the economy helped mortgage rates on 30-year-fixed loans go for about 6.5%, to the 3.4% historic lows of today’s mortgage rates.

Numerous people took advantage of the opportunity to borrow, excluding refinancing mortgages and new property loans.

According to the Wall Street Journal story, banks have difficulty keeping up with the demand, which takes the largest loan companies about 70 days to complete a refinance.

However, the long wait is not enough for many homeowners to discontinue as stated by the Mortgage Bankers Association. Within the last week of September, the number of refinance applications has reached its highest level in three years time.

When you think about it, refinancing your loan can help you save more money in terms of interest as well as help lessen your monthly payment.

Then again, this supposedly money-saving method can also generate the opposite effect.

Listed here are five common scenarios in which refinancing has shown to be an expensive method.

1. It is impossible to cut down your interest rate to balance out the costs of refinancing.

Probably, one of the reasons you are interested in refinancing is because you want to lower the interest rate.

Unfortunately, refinancing is costly whether it is out-of-pocket expense or new financing. See to it that you can regain those expenses, which make up 2 percent of the total amount borrowed.

You should also take into account that it could add a few more years to the loan. Check out the monthly interest you are paying as well as the principal (both with new and old loan).

You may obtain a lower loan payment with your new loan each month, but a big part of that payment might just go to the interest instead of your present loan. That is a major factor.

2. You try to pay the loan sooner

If you are earning more money from the time you purchased your house, you could be thinking of refinancing to a shorter loan term, for example 15 years. It normally comes with a higher payment per month but lesser costs of lifetime interest compared to a 30-year mortgage. While it is a good plan, you should make additional payments to your existing loan to pay the amount as soon as possible.

By doing this, you avoid the costs of refinance and save in interest at the same time.

Compute the amount you need to pay every month to your current loan within the time period that you would pay your loan proposal, again  the 15-year example.

In that case, multiply the amount of additional unscheduled payments by the number of your payments. This formula is your expected lifetime cost of your present loan, which is paid off much sooner.

After that, perform the same thing to your proposed loan and add the costs of refinancing. It will be the lifetime value of your mortgage loan. At this point, you can do a comparison of both numbers.

3. You choose an adjustable rate to reduce your rate

When it comes to an adjustable rate mortgage (ARM), you will have a low interest rate for a certain time period, usually from 1 to 7 years. However, your ARM rate is likely to adjust to the going rate, not like with a fixed-rate mortgage. The thing is, expect to see the interest rates going up.

4. You plan to sell your house in the near future

Considering that refinancing does not come cheap, you want to make sure that you have enough time to regain the costs while you are still living in that house.

If at all possible, you wish to keep your refinanced loan go beyond the break even point. That is the time when you seriously begin to save money.

5. The long-term rates are greater than the savings

At the outset, refinancing looks like the right choice. And when you do some math, you soon figure out that it is not an excellent option after all. You are in fact, adding more years to your loan.

Almost always, you need to pay more when you refinance mainly because of the additional years of interest, no matter how low the rate is.

Ask your mortgage consultant to compute your interest on your current loan, and the time frame you think you can keep the loan. Next, compare it to the amount of the costs of your proposed loan plus its interest cost within the same time period. All things considered, the actual cost of your loan is the refinancing costs and  the interest.

6. The fees

Excluding the junk fees, the refinancing cost can offset the savings from your lower payment per month in your new loan. Carefully examine your refinancing costs to ensure your savings can repay those charges in an average time period.

The Federal Reserve says that the average fees range between $1,900 and $3,650, minus the private mortgage insurance, loan discount points, or loan origination cost.

A refi calculator can show your break-even point; your lower payment with the number of months to pay, so you can recoup the costs of your refinancing.

The National Bureau of Economic Research calculator can also determine if the interest rates have dropped low, which is enough for you to look at refinancing.

7. Prepayment penalties

Your could have a penalty for paying off your original mortgage early, as such the case when you refinance it. The loan for the Truth in Lending statement should have details about a penalty.

When using the refi, add any penalty charges in computing the time period to break even. If you are dealing with the same mortgage lender, ask if it is possible to waive the penalty.

8. Small savings

 The rock-bottom mortgage rates at this time are just 1.5 percentage points as compared to the case two years ago. Since then, a lot of people have been refinancing and will not save them money by doing the process again today.

In the long run, refinancing may not be a good option for you unless you lower the interest rate by a minimum of a point and a half.

Latest posts by ratetake (see all)

Written by ratetake


Martin is Head of Real Estate and Finance division at RateTake. He creates content that helps people understand and make the right decisions for their financial future.