Refinancing always sounds like a good idea. Whether you save money on your mortgage payment or you consolidate your debt to save money. The bottom line is that you save money. This is a good thing, right? It isn’t always the right choice. There are certain times when you should not refinance. Understanding these reasons will help you look at your situation with a microscopic lens to determine the right choice.
You Don’t Have the Money
This might seem like a strange reason not to refinance. Shouldn’t you go ahead with it in order to save money? The problem occurs with the closing costs. You still have to pay them. If you don’t have the money to pay them at the closing, you may wrap them into your loan amount. This is if the lender allows it. Now you diminish the savings you would have obtained by refinancing. Usually adding the closing costs to your loan makes your loan payment higher. Even just a few thousand dollars can make a significant difference in your loan payment. The savings you thought you had are suddenly gone.
You Can’t Afford a Shorter Term
Stop and think about how long you have had your loan. Has it been a few years or much longer? If you have made payments for more than a few years, you are probably paying more principal than you realize. If you were to refinance back into a 30-year term, you start back at square one. You might think this is a good idea if you save money. Looking back, though it is like paying interest twice. You already paid interest for the first few years of your loan. Paying down the principal is the goal, but is one you will have to wait to touch if you refinance into the same term. If you cannot afford to go from a 30-year to a 20-year, for example, you probably should not refinance.
You Can’t Meet the Break-Even Period
The break-even period is when the refinance “pays off,” so to speak. This is when you start realizing the savings after recouping the amount paid for closing costs. For example, if the refinance potentially saves you $150 per month and your closing costs equaled $2,500, it would take you 16 months to recoup the closing costs. If you know you plan to move in less than 1 ½ years or so, it does not make sense to refinance. You are better to pay the higher interest rate for the time you have left in the home. On the other hand, if you plan to stay for the long-term, you can recoup the closing costs and reap the savings after the 16-month period. This gives you a better chance to see just how much you would save over the life of the loan, given your current life circumstances.
You Should Not Refinance Into an ARM
ARM rates might seem so ridiculously low that it would be dumb to not refinance. This is just a teaser or introductory rate, though. You have to look at the big picture. Sure, you might be able to secure an interest rate up to 2% lower than your current fixed rate, but what happens after the introductory period ends? You are left with the unknown. Rates are low right now, so low in fact, that experts do not see them decreasing in the future. This only means one thing – higher rates down the road. Your ARM rate could seriously increase, making your payments unaffordable in the future. You might think if you plan to move before the rate change date that you will be safe. This is a gamble, though. You have no idea if you will be able to sell your home at any given point. As the housing crisis showed, values can drop quickly. Rates can also increase dramatically. What if no one can afford a new mortgage? You are then stuck with an unaffordable mortgage.
You Don’t Have Good Credit
Your credit score plays a vital role in refinancing, much as it did with your purchase. Sure, you might be able to secure a refinance, but it might not be for the low rate you anticipated. The rates you see advertised are usually for those with stellar credit and the perfect scenario. This rarely happens in real life. There are adjustments the lenders make to the basic rate. This increases your final rate and decreases your savings. This is especially true if you have a blemished credit history. You pose a risk to the lender. They may be willing to provide you with a new loan, but will only do so for a price. Is this price worth you paying?
If you want to refinance, really look at the big picture. Consider the savings, not only now, but well into the future. Take a close look at the closing costs and the APR. You need to know what the loan really costs. When you look at the scenario this way, you have a better chance at making the right choice. If you choose not to refinance, it is okay. Even though it seems like the thing to do, it is not always the smartest choice. Don’t do what your neighbors or friends do – only do what is right for your financial situation now and in the future.