"Refinancing saves thousands," "refinancing lets you get your life back," "refinance and get control of your money," etc., etc.
You've probably seen dramatic ads saying these things, or perhaps you heard a friend saying refinancing changed their life for the better.
It's tempting, right? Swap out your old loan for a shiny new one and keep more money in your pocket. But you're forgetting one thing – nobody is actually out to help you. No bank wants you to keep more money for yourself because that's not how banks work.
Refinancing isn't free, and it's not a smart move for everyone. It can be good, but it can also cause a world of problems.
So how is it right for you?
5 Situations When Refinancing Saves You Money
If the numbers line up in your favor, go ahead with refinancing. Here are the most common ways refinancing can work for you, not against you.
Lower Interest Rates with Sufficient Time Remaining
If the interest rates go way below what you're currently paying, refinancing is a good move to make. If you have a lot of time left on your mortgage, even a smaller reduction in your rate can save you thousands over the life of the loan.
But the key here is time – if there's only a few years of payments left, you might pay more in fees than you'll save.
Eliminating Private Mortgage Insurance
If you bought your home with less than 20% down, chances are you're paying private mortgage insurance. This makes your monthly payment higher, and it doesn't build any equity for you.
Once you've built enough equity in your home, you can remove this insurance requirement if you refinance.
Switching from Adjustable to Fixed Rate
Adjustable-rate mortgages look great at first because they usually start out with a lower interest rate.
But once that adjustable period is over, your payments can spike (depending on your market, of course). If you were to refinance into a fixed-rate mortgage at this point, you'd get more stability and predictability.
It's an especially good move if the rates are expected to rise because you can protect yourself from sudden jumps later on.
Consolidating High-Interest Debt
Some people decide to roll high-interest debts like credit cards and personal loans into their mortgage at a lower rate. This can lower your monthly payments, but only if you don't build new debt.
Veterans can also qualify for special programs that make it possible to refinance with a VA loan for better terms.
Reduce/Shorten the Term
Most people don’t want to be stuck paying off a loan for 30-40 years. There are ways to reduce (even halve) the loan term by opting for refinancing.
Your monthly payment will go up, sure, but as long as that isn’t a burden, you’re saving a lot of dollars over the whole course of the loan. This way, you’ll pay off the mortgage much quicker and reduce the interest by a huge margin.
And if you end up in a position where the monthly payments are too much, you can always refinance to make them smaller.
Only this time around, you’ll have already paid a good chunk of the entire loan, meaning you aren’t adding as much as you had before.
3 Situations When Refinancing Doesn't Make Sense
There are many cases in which refinancing can actually drain your wallet further.
Here are some of them.
High Fees That Cancel Out Savings
Every refinance comes with loan origination fees, appraisals, title searches, and closing expenses, which can add up to thousands of dollars. This means that you could be adding literal years to your breaking even on those fees.
If what you'd be saving every month isn't a lot of money, refinancing isn't worth it.
Planning to Move Soon
If you think you'll be selling your home in the next few years, refinancing doesn't make sense.
You won't stay long enough to offset the upfront costs, which means you'll hand over a decent chunk of money to the bank and never get it back.
Extending the Loan Term Too Far
One tempting offer is to reset your mortgage back to 30 years.
Yes, your monthly payment will drop, but when you stretch your debt over such a long period, you'll pay more in total interest. What looks like short-term savings can easily turn into tens of thousands more over the life of the loan.
The math ain't mathin'.
Conclusion
Sure, there are other things to think about, such as refinancing while having a weak credit score, ignoring market conditions when signing up for a loan, having already a low interest rate, prepayment penalties, having a high remaining balance but short term left, etc., but you get the gist. The four above are the most important ones.
Banks aren’t your ‘friend’. But that doesn’t mean that they’re out to get you. They’re businesses. And they do their business in order to earn money. They offer a service that you need, and you pay for that service. It’s that simple.
What this article is all about is that you need to know exactly what you’re paying for and signing before you commit. Refinancing can often be a good move. But there are situations where it can land you in more debt than you initially had.
Put everything down on paper. Crack the numbers. And then make a decision.
In this situation, numbers are the only ‘friend’ you should trust.
