Mortgage interest rates are at all-time lows, which means that refinancing your home should be a no-brainer, right? Wrong. The truth is that refinancing your mortgage is a big decision involving many factors.
And according to industry experts, being able to reduce your monthly mortgage payment or lower your interest rate are not always the best reasons to refinance. As you'll see below, refinancing your mortgage can backfire and actually end up costing you money - not to mention a lot of paperwork.
But, of course, for every bad reason there is an equal and opposite good reason. Under the right conditions, refinancing your home could save you a lot of money.
"For anyone who is able to refinance, and for whom it makes financial sense, I'd say do it," says Jim Duffy, a mortgage banker with Cole Taylor Mortgage. "Rates are historically low right now and there may never be a better opportunity."
You may be willing and able to refinance, but does your financial situation put you in the good reason column? Read on to learn about popular reasons to refinance - and whether it's a good or bad rationale.
#1 - Everybody's Doing It
Verdict: Bad Reason
To illustrate a key point, let's channel the wise words of mothers around the world: "If all your neighbors jumped off a cliff, would you?" Well, when it comes to refinancing, like jumping off a cliff, it's really not for everyone.
After all, mortgage amounts and terms vary considerably, says Fred Arnold, a mortgage professional and president of the Association of Mortgage Professionals. Add to that the fact that each person's financial and family situation is very different, and Arnold says it's no surprise that a professional is needed to determine if refinancing is a smart move.
So, before you just go ahead and follow the crowd, make sure to think long and hard about whether or not refinancing is really a beneficial step for you.
We know you hate to admit it, but sometimes mom is right.
#2 - You'll Save Money
Verdict: Good Reason
Let's not kid ourselves; you don't refinance to impress the neighbors (that's what your new lawn is for). It's all about the Benjamins, i.e., the money.
Arnold agrees, confirming that whether or not refinancing makes sense for you comes down to a simple test: "It's only a great time to refinance if you're going to save money by refinancing and if it works with your long - or short-term - financial goals."
If you refinance right, you could save tens or even hundreds of thousands of dollars over the life of your loan, says Arnold. Do it wrong, and it could cost you.
For example, if you decide to refinance, but end up moving in a year or two, chances are you'd still be paying off the refinancing costs and would thus lose money, rather than save money by refinancing.
#3 - To Get an Adjustable-Rate Mortgage (ARM)
Verdict: Bad Reason
Do those super-low interest rates on adjustable-rate mortgages (ARMs) look too good to pass up? Well, unless you are in a unique circumstance, an ARM is likely not the best option for you, says Duffy.
But first, what the heck is an ARM? Essentially, an ARM offers an interest rate that changes periodically, often in relation to an index, and as a result, payments may go up or down accordingly.
And while it's nice when rates and payments go down, it can definitely take a toll on your wallet when rates go up.
This is precisely why Duffy argues against getting an ARM.
"With 30-year fixed mortgage interest rates at historic lows, going with an ARM can mean losing on long-term historically low interest rates to get short-term gains," says Duffy.
#4 - To Get a Fixed-Rate Mortgage
Verdict: Good Reason
Stressing is no fun. And one way to relieve stress when it comes to financial matters is to lock in the amount you will pay each month for your mortgage for the next 30 years, says Duffy. How do you do this? Get a fixed-rate mortgage.
Since rates are at historic lows, it might be the right time to refinance to a 30-year fixed-rate mortgage to give yourself some peace of mind, no matter what the future holds, adds Duffy
"If the housing market doesn't rebound as quickly as people are hoping and someone has to move, it gives them the option of being able to keep and rent the house and know what their monthly loan payment is," says Duffy.
If they had an adjustable-rate mortgage, he argues, they might not know whether the rent would cover their mortgage payment when the rate changes.
Talk about stress.
#5 - To Get a Lower Interest Rate
Verdict: Good and Bad Reason
Refinancing is all about getting a lower interest rate. Unfortunately, getting a lower interest rate doesn't always mean that you'll be saving money in the long run.
The reason is simple: refinancing costs money. Closing costs typically include such things as loan origination fees, appraisal fees, application fees, and other such charges, says Duffy. What's more, they can be anywhere from 1 to 2.5 percent of the amount you are borrowing, depending on the interest rate.
Recouping closing costs in savings through a reduced monthly payment could take up to two years, so before refinancing to a lower rate, make sure you'll actually be able to benefit from the savings in the long-term.
"A good rule of thumb is you've got to lower your interest rate by at least one percent," says Duffy. What's more, you should also plan to stay in your home for long enough to recoup the refinancing costs and enjoy some savings.
Everyone's situation is different, but simple math can usually tell you whether refinancing is a bright idea.
#6 - To Lower Your Monthly Payment
Verdict: Good and Bad Reason
Does a few hundred dollars less in a mortgage payment every month sound super? Even a reduction of a hundred bucks a month probably sounds pretty good. But beware. There are certain circumstances in which even a lower monthly mortgage payment does not result in savings.
The main issue, as mentioned above, is again closing costs.
Duffy says that if you're going to be moving shortly, you're going to throw money away because you won't have time to recoup the closing costs through savings on your monthly payment.
If you plan on staying in your home for quite awhile, however, refinancing is a great way to help cut monthly payments, he says.
Here's an example of a refinance that lowers the monthly payment by $348.12 on a $300,000, 30-year fixed-rate mortgage. We'll also assume closing costs of 1.5 percent, which Duffy says is typical. That's $4,500. We'll further assume the homeowner has an existing interest rate of 5.35 percent and qualifies for a 3.38 percent interest rate, the market rate as of November 27, 2012, according to Mortgage News Daily, an organization that provides housing news and analysis.
|Existing Mortgage||New Mortgage|
|Interest Rate:||5.35 percent||3.38 percent|
|Monthly Loan Payment:||$1,675.24||$1,327.12|
|Total Amount of Payments:||$603,086.79||$477,762.87|
|Total Interest Paid:||$303,086.79||$177,762.87|
In this scenario, the borrower would recoup their closing costs in 13 months. And over the life of the loan, they would save an impressive $125,323.92 in interest. I think we can say with confidence that saving over $100,000 in interest is a good reason to refinance in anyone's ledger.