Homeowners consider refinancing their mortgage for a number of reasons. Some are in a hurry to refinance to lock in lower interest rates, while others refinance to get rid of private mortgage insurance for a lower payment or use their home's equity to consolidate debt.
Since mortgage rates are still historically low, refinancing your home can make a lot of sense financially to get a better rate and term. Recently, the average 30-year fixed mortgage interest rate has hovered below 3%, according to Freddie Mac. If you’re considering refinancing your home, you can explore your mortgage refinancing options by visiting Credible to compare rates and mortgage lenders.
However, for some home borrowers, refinancing might be a bad idea. Read on to learn when it’s a bad idea, so you can avoid making a potential mistake.
1. Bad credit or credit score
If your credit score has dropped since applying for your first home mortgage, your mortgage refinance rate could end up being higher than your current mortgage rate. Plus, if your credit score has fallen too low, you might not meet the minimum credit score requirements for a loan refinance.
For example, if you have a Freddie Mac or Fannie Mae loan, the minimum credit score needed for some mortgage loans is 620.
2. Cost of fees
Similar to taking out your original mortgage, mortgage refinancing sometimes comes with closing costs. These closing costs may apply for various types of mortgage loans such as VA loans, FHA loans or USDA loans. Although closing costs typically range from 2% to 5%, the amount you’ll pay depends on the lender.
For example, if your closing costs are 5% on a $120,000 mortgage loan, you’ll have to pay $6,000. Depending on your financial situation, this might be unaffordable for you, especially if it means draining your emergency fund.
3. You’ll be moving soon
If you plan on selling your home soon, the short-term costs of refinancing might outweigh the benefits like a lower interest rate. The longer you stay in your home, the higher the probability is of you reaching a break-even point. This is the point where the savings you get from refinancing your mortgage cancels out the cost of fees.
4. Your new monthly payments will be too high
Changing your loan term could save you money with a lower interest rate, but could increase your mortgage payment. To save the maximum amount of interest, some homeowners choose to refinance their 30-year fixed mortgage to a 15-year fixed mortgage. This can cut the amount of interest you pay over the life of your mortgage loan in half. However, doing so can also double your monthly mortgage payments.
If you can’t afford the new monthly mortgage payment on your home loan, this increases the risk of having the lender foreclose on your home. Before you refinance to a short-term loan, use an online mortgage calculator to determine your new monthly costs. That way, you’ll know if the new costs fit your budget.
5. Debt consolidation
If you’re refinancing your mortgage for the purpose of debt consolidation, you could do a cash-out refinance. This involves taking out a new, larger loan to tap into your existing home equity. Your lender will pay you the difference between the larger loan amount and your existing mortgage in cash.
Although this can save you money, it comes with risks. For example, if you struggle to repay the larger loan or default, it can destroy your credit and you can lose your home.
6. Your mortgage rates are still favorable
If your refinance rate is comparable to today's mortgage rates, you might not save a lot by choosing to refinance your mortgage. Before refinancing your mortgage, compare your current mortgage rate with the average interest rate.
The average mortgage rate for a 30-year fixed-rate mortgage as of early June still hovered just below 3%.
Over the last month, mortgage rates have been trending downward. To check whether today’s rates are lower than your current rate, visit Credible to compare rates across multiple mortgage refinance lenders at once.
The bottom line
Although some homeowners can save a lot of money by refinancing their mortgage, it doesn’t mean that it’s a good idea for every homeowner. Refinancing your mortgage can be a bad idea if you have a bad credit score, you can’t afford the fees or new monthly payments, or you won’t stay in your home long enough to enjoy the benefits.
Before refinancing your mortgage, review your unique financial situation to see whether it makes sense. If it does, Credible’s fee online tool can help you easily compare multiple lenders and see prequalified rates in as little as three minutes.
Have a finance-related question, but don't know who to ask? Email The Credible Money Expert at email@example.com and your question might be answered by Credible in our Money Expert column.