When Home Mortgage Refinancing Is Not a Good Idea
Sometimes it's Best to Stay Put
Home mortgage refinancing can look appealing to homeowners looking to reduce expenses. But it’s not always a good idea. Depending on your situation, refinancing can either save you money or cause a variety of problems. While the lure of lower interest rates and smaller monthly payments makes sense at first glance, it’s crucial to understand the potential risks involved.
This page specifically covers how home mortgage refinancing can land you in hot water or be a welcome change providing a financial boost. If you just want an overview of how home mortgage refinancing works before weighing the pros and cons, get the facts by reviewing Mortgage Refinancing Basics. As a refresher, when you refinance your mortgage, you get a new loan that pays off your existing debt. Doing so can result in lower monthly payments unless you take out a substantial amount in cash.
In general, you should avoid refinancing your mortgage if you’ll waste money and increase risk. It’s easy to fall into the traps below, so make sure you steer clear of these common mistakes.
Extending a Loan’s Term
When you refinance, you typically extend the amount of time you’ll repay your loan. For example, if you get a new 30-year loan to replace your existing 30-year loan, payments are calculated to last for the next 30 years. If your current loan only has 10 or 20 years left to go, refinancing is likely to result in higher lifetime interest costs.
Here’s why: When you get a new loan with a long term, most of your payments primarily go toward interest charges in the early years. But with your existing loan, you might have already moved past those years, and your payments might be making a meaningful dent in your loan balance. But if you refinance, you have to start from scratch. To avoid losing substantial ground, you can choose to use a shorter-term loan, such as a 15-year mortgage.
To see this in action, plug your numbers into a loan amortization calculator to see specifically how the interest costs change (along with your monthly payment). While you're at it, learn how amortization works if you’re curious about the process of paying down loan balances.
Refinancing a home loan costs money. You typically pay fees to your new lender to compensate them for offering the loan. You may pay a variety of charges for legal documents and filings, credit checks, appraisals, and so forth.
Even if a loan is advertised as a "no closing cost" loan, you still pay to refinance. In many cases, that happens through a higher interest rate than you would otherwise pay. To better understand no closing cost refinance loans, research the basics of such loans to avoid common pitfalls.
When you choose a loan with “no closing costs,” you may pay a higher rate for the life of your loan instead of paying one-time fees.
You can use home equity to consolidate debts. To do so, you might refinance your existing loan with an even larger loan. Also known as cash-out refinancing, this approach provides additional cash that you can use to pay down credit cards, auto loans, and other debts.
Debt consolidation may seem appealing because you reduce interest rates on your debt by converting consumer debts into lower-interest-rate home equity debts. But that move can backfire if all you do is free up capacity on your credit cards and rack up more consumer debt. Moving debt around is not the same as paying it off.
It can also backfire if you are unable to pay the larger loan balance and risk losing your home. If you’re having trouble paying consumer debts, think twice before putting your home on the line. Consider enrolling in a debt consolidation program before taking such a drastic step.
In some states, home purchase loans have special protection from creditors: In the event of foreclosure, lenders might not be allowed to sue you if they lose money on your loan and subsequent home sale. Those legal actions, known as deficiency judgments, can haunt you even after you leave your home.
But those rules apply to your original purchase loan, and refinancing your mortgage changes the nature of your loan: It’s no longer the original loan you used to purchase your home. As a result, you may lose some protection.
Before refinancing a home loan, familiarize yourself with how recourse loans work and ask a local real estate attorney for guidance.
Federal Reserve Board. "A Consumer's Guide to Mortgage Refinancings." Accessed Jan. 10, 2020.
Quicken Loans. "Refinance Without Closing Costs." Accessed Jan. 10, 2020.
Consumer Financial Protection Bureau. "What Do I Need to Know If I’m Thinking About Consolidating My Credit Card Debt?" Accessed Jan. 10, 2020.
Connecticut General Assembly. "Comparison of State Laws on Mortgage Deficiencies and Redemption Periods." Accessed Jan. 10, 2020.