Top Reasons Not To Refinance: When And Why Refinancing Might Be A Bad Idea
Molly Grace7-minute read
November 11, 2023
Interest in refinancing has experienced a huge surge among homeowners in the past year thanks to record low interest rates. In the summer of 2020, the average rate dipped below 3% for the first time ever.
It’s natural for borrowers to want to take advantage of low rates. Refinancing your mortgage can come with a lot of benefits, including lowering your monthly payment and saving you lots of money in the long run.
But it’s important to understand that it isn’t always a smart financial move. Whether refinancing makes sense for you depends on your individual situation.
Here are some reasons why you might not want to refinance your home.
What To Consider Before Refinancing
When you refinance your mortgage, you’re taking out a new loan to replace your current one. Homeowners typically decide to do this because there’s a benefit to getting a new loan, such as snagging a lower rate or shortening their term length.
The process is pretty similar to what you’ll go through when you get a mortgage to purchase a home. With a refinance, however, instead of using the new mortgage to purchase a home, you’ll use it to pay off your current mortgage. You’ll then make monthly payments on the new mortgage.
Anytime you’re taking out a large loan like a mortgage, it’s a big deal. Here are some things homeowners should think about if they’re considering refinancing.
Getting a loan isn’t free. With any mortgage, including a mortgage refinance, you’ll have to pay closing costs. In general, closing costs are between 2% – 6% of the loan amount.
Closing costs are usually paid in cash at closing. If you want to keep your upfront costs low, it’s also possible to roll your closing costs into the cost of the loan, or to have the lender cover your closing costs in exchange for you taking on a higher interest rate. This is known as a no-closing-cost refinance.
Your Credit Situation
Just like when you apply for a mortgage to purchase a home, you’ll need to meet a lender’s credit requirements to be approved for a mortgage refinance.
If your credit score has changed since you first got your mortgage, you’ll want to make sure it still meets typical lender requirements for mortgage approval (usually 620 for a conventional loan, 580 for an FHA loan). If your credit is too low to refinance, you might need to spend some time repairing your score before applying.
Lenders will look at other aspects of your financial situation as well, such as your debt-to-income ratio, your work history and the amount of equity you have in your home.
Your Loan Term
When you refinance, you’re taking on a new loan, which might mean either extending or shortening the length of time you’ll spend paying off that loan.
Let’s say you bought your house using a 30-year mortgage. You spend a few years paying your mortgage, then decide you’d like to refinance. You might choose to refinance into another 30-year mortgage, meaning you’re essentially resetting the clock on your term, or you might prefer a shorter term than what you originally got, such as a 15-year mortgage, which can raise your monthly costs but save you more money in the long term. You may even be able to refinance into a term that matches the amount of time you had left on your original loan.
The loan term that’s best for you depends on your goals.
Equity is your ownership interest in your home. It’s the amount of money you have in your home that isn’t tied up in your mortgage.
For example: You buy a house for $200,000. For this purchase, you put down 20%, or $40,000. The mortgage covers the remaining $160,000. This means that you’ll immediately start with 20% equity in your home. As you pay your mortgage each month, or if your home’s value goes up, that percentage will get larger.
You may need to have a certain amount of equity in your home before you’ll be able to refinance.
Depending on the type of loan you have and the type of refinance you’re getting, you may be required to wait a certain amount of time after the closing of your original loan before you can refinance.
Additionally, if your loan has a prepayment penalty, you may want to wait a few years until the penalty no longer applies before refinancing. There are no prepayment penalties with Rocket Mortgage®.
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When To Not Refinance Your Mortgage
Here are some situations where refinancing might not make sense.
1. It Will Take You Too Long To Break Even
If you plan to refinance to a lower monthly payment, you might assume that you’ll immediately start saving money. But that isn’t necessarily the case.
To calculate your savings, you have to factor in how much you spent getting the loan and consider how long you plan to stay in the home. So, say you spent $8,000 on closing costs. Once you break even on that amount, you’ll have fully recouped the costs associated with getting the loan. After that, you’ll begin actually saving money.
It can take a while to reach this point. From our example above, say you spent $8,000 to refinance into a loan that saves you $100 each month. To figure out your break-even point, you’ll divide the total cost of the loan by your monthly savings.
8,000 ÷ 100 = 80
In this example, it will take 80 months, or over 6 years, to break even.
2. It Will Cost You More In The Long Run
Depending on the type of refinance you get, your new loan could end up costing you more money in the long run than if you’d just stuck with your original loan.
This can happen when you extend your loan term, because you’re lengthening the amount of time you’ll spend paying interest.
However, extending your loan term can come with a lot of benefits, especially if you’re having trouble keeping up with your current mortgage payment. Having a more manageable monthly payment may be worth the trade-off for some homeowners.
3. You Already Have A Low Fixed-Term Rate
If rates are lower than what your rate on your current mortgage is, it might seem like a no-brainer to refinance.
But if your rate is already relatively low and current rates aren’t significantly lower than yours, you might not end up saving as much money as you thought you would.
4. You Can’t Afford Your Closing Costs
Closing costs include things like appraisals, origination fees and other costs associated with preparing and closing on your loan.
As we mentioned above, these can cost between 2% – 6% of your loan amount, which is a significant chunk of money. If you don’t have enough cash, you might be tempted to roll your closing costs into your loan amount or take on a higher rate to avoid paying these costs upfront.
However, when you do this, you’re potentially cutting into the savings from your refinance because now you’re also paying interest on those costs.
5. You Plan To Move In A Few Years
There’s typically not much of a benefit to refinancing if you’re planning to sell soon.
Remember your break-even point? If you sell your home before you reach that point, you won’t fully recoup the money you spent getting your loan – to say nothing of the savings you could be missing out on.
6. Your Credit Score Is Low
If you have a lower score than you did when you were approved for your original mortgage, you could end up being offered less attractive terms on your refinance. This is also true for other aspects of your financial situation, such as if your debt-to-income ratio has increased.
7. A Higher Monthly Payment Will Stretch Your Budget
Sometimes, homeowners will refinance into a shorter-term loan to pay off their mortgage faster and reduce the amount they’ll pay in interest over the life of the loan. However, this can be risky since it typically locks you into a higher monthly payment.
The benefit of having a lower monthly payment is that it gives you more wiggle room if you encounter a period of financial difficulty or you have a month where your budget is tighter than usual.
If you want to pay off your loan faster but aren’t sure if refinancing into a shorter term would be a good move, it might make more sense to just make additional payments each month. That way, you have the flexibility to make larger payments when your budget allows for it and only pay your normal amount when you don’t have the extra cash.
Plus, even if you have the extra money in your budget to take on a higher monthly payment, you might decide that money could be better used elsewhere, such as saving for retirement or investing.
8. You’re Unnecessarily Risking Your Equity
A cash-out refinance allows you to tap into the equity you have in your home and convert it into cash. This can be especially useful for things like paying for a renovation project that boosts the value of your home or paying down a large amount of high-interest debt.
However, cash-out refinances aren’t always the best financing option, since you’re taking equity out of your home and creating extra debt that’s secured by your home.
If you’re considering a cash-out refinance, think about how you plan to use that money and whether it will help or hinder you financially. Cash-out refinances can be beneficial to homeowners, but it’s important to weigh the pros and cons before deciding whether it’s right for you.
9. You Haven’t Done The Math
Ultimately, whether or not a refinance makes sense for you comes down to math. Everyone’s situation is different, and the only way to know whether a refinance will help you meet your goals – whether that’s to lower your monthly payment, pay off your loan faster or save money on interest – is to do the math based on your individual numbers.
You can get started by plugging your numbers into our refinance calculator to see how much you could potentially save.
The Bottom Line
There are pros and cons to refinancing. There's no hard-and-fast rule about whether refinancing is good or bad; as we’ve said, it’s all dependent on your situation.
In fact, there are a lot of great reasons to refinance, from saving money to shortening your term to taking out cash. Whether it’s a good idea or a bad idea just depends on what’s right for you.
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