During low-rate environments, the clamor to refinance is automatic. There’s no clear-cut answer to how often should you refinance your mortgage and there are homeowners who refinance again (and again) to save more. Are these homeowners guilty of serial refinancing? Is serial refinancing really bad?
What Is Serial Refinancing?
Historically low interest rates as seen in the wake of the historic Brexit vote are the drivers of refinancing. There’s also the promise of no out-of-pocket closing costs, which accompanies these refi deals.
Understandably, homeowners would want to lower their rates to realize more savings. Even a quarter off your current interest rate could mean 2 and 2.5 years off your loan.
Benefits of Refinancing
The prevailing rate environment and the desire to save thus lead to the phenomenon of serial refinancing, which is not exactly a bad thing in itself if you think about its purported benefits.
With refinancing, you can:
- Obtain a better rate
- Lower your monthly payment
- Shorten the loan’s term
- Reduce the interest you pay
- Borrow against equity
- Eliminate private mortgage insurance
- Add a co-signer
Refinancing Too Much?
Repeated refinancing can be troublesome if it affects your credit standing or worse drains your finances. Here are some pitfalls of serial refinancing and what you can do to avert or mitigate them.
1. Credit Score. Every time you apply to refinance, your lender will pull up your credit record. This results in an inquiry that impacts your credit score. Multiple inquiries will have a lesser impact if made within 45 days as in the case of mortgage rate shopping.
If you get approved for refinancing, the new loan appears on your credit report. This new loan lowers the age of your credit history, which is basically how long you’ve kept an account open. When you refinance every year, two years, or three years, you lower this average credit account age, which is 25% of FICO’s scoring computation.
Payment history and amounts owed still hold the larger chunks, 35% and 30% respectively, of FICO scores. How important each category is would depend on your personal circumstances.
2. Closing Costs. Every time you refinance, you pay a new set of closing costs. Costs and fees, as applicable, could add up to 1% to 4% of your total loan amount. These closing costs can be paid by you upfront, rolled into the loan, or covered by the lender in the form of a higher rate.
A cost-effective way to pay for closing costs is through discount points. Each discount point is a prepaid interest or fee that represents 1% of the total loan amount. If you plan to stay longer in the home, it makes sense to use these discount points for closing costs.
3. Cut back or extend the life of the loan. Shortening the term of your loan means higher monthly payments but a shorter time to pay it back. Taking out a longer-term loan, on the other hand, is restarting your loan and paying more in interest.
But even with a new 30-year loan, you can pay it off faster by putting in extra payments to the loan principal every month. You can ask your mortgage servicer to run an amortization schedule that allows you to see how much needs to be made to pay off the loan at a certain period.
If your break-even analysis tells you that you’ll realized more savings than all your costs combined every time you refinance, then those pitfalls would tip the scales in your favor.
Justin McHood is a managing partner at Suited Connector and has been recognized by national media outlets as a financial expert for more than a decade.