Sometimes a Mortgage Refinance Is NOT a Good Idea (Even If It Lowers Your Interest Rates)
Unfortunately, many mortgage lenders fail to tell you this. But for many homeowners, a refinance loan is an awful idea… even if it were to lower your interest rates.
That may not make sense, until you consider how many months and years you’ve been paying interest on your current mortgage.
If you refinance your current mortgage loan with another loan of the same term, then all the months and years you’ve been paying have been wasted. Depending on how long you’ve had your current mortgage, a refinance loan may be a bad idea — even if you get the best mortgage loan with the lowest interest rates from the top mortgage lender in your area.
An Example of a Money-Losing Refinance
Stuart has a 30-year fixed-rate loan that he has been paying on for six years. The interest rate is 7.00%. With the original loan amount of $100,000, his current loan payments are $665.30 per month for just principal and interest (P&I).
His mortgage broker offers him a 30-year refinance loan to 5.00%. With a new mortgage balance of $95,000, his new monthly payment would be $509.98.
According to his mortgage broker, Stuart would save:
- $155.32 per month
- $55,915.12 for the entire life of the loan.
Unfortunately, that’s not the whole picture. This mortgage refinance will actually end up costing Stuart a great deal of money:
- $40,593.33 in interest he’s already paid
- $4,000 in closing costs for the refinance
- Five (5) more years paying off his mortgage
When you take the total cost of this refinance ($44,593.33) and subtract that from the projected saving over the life of the loan, Stuart will actually only gain $11,321 from this refinance — over 30 years!
Does that make sense, especially when you consider that he has to pay his mortgage over 30 years… instead of just 24 years (if he kept his current mortgage loan)?
It’s even worse if you roll the closing costs from the refinancing into your new mortgage loan. In such a case, you would be paying interest on your closing costs.
Refinance Sensibility Checklist
If you’ve had your current mortgage loan for several years, you can use this checklist to determine whether or not a refinance really makes sense for you.
Of course, you need to compare apples to apples. If you’re applying for a cash-out refinance loan or shortening the term of your loan, then your potential benefits and savings may be higher.
If you’re replacing your current loan with one with the same term, then you should use this checklist to fully understand the financial implications of your mortgage refinance loan.
- Add up all the interest you’ve paid to date. You can use the mortgage calculator on the right to generate an amortization table or you can simply add up your monthly mortgage payments since the start of your loan to get a rough estimate.
- Add the cost of the refinance. Get an estimate from a reliable mortgage broker or lender on the cost of a mortgage refinance.
- Total cost and loss from a refinance. Add the two items together to determine the total amount you will be losing if you were to refinance with a loan of the same term as the original (a 30-year loan for a 30-year loan).
- Calculate savings from the refinance. Determine the gross amount you’ll be saving over the life of the loan if you were to refinance to a lower rate. You can do this by subtracting your new mortgage payment from your current mortgage payment, to get a rough estimate of your savings; then multiply by the months in the refinance loan term.
- Compare costs versus savings. Now compare the estimated savings from the refinance against the total cost and loss from a refinance.
How long will it take you to recoup the cost of refinance loan, based on the monthly savings? Does it make sense? Are you okay with extending your mortgage loan a few (or several) more years?
Your answers to these questions will help you quickly determine whether or not a refinance really makes sense for you.
