1 Huge Risk of Refinancing

by Maurie Backman | Published on Sept. 1, 2021

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If you don't crunch the numbers, you could actually end up losing money by refinancing.

There's a reason so many homeowners have refinanced their mortgages over the past year. Refinance rates have been sitting at attractive levels since last year, and if you swap your current home loan for a new one with a lower interest rate attached to it, you might lower your monthly payments substantially.

Say you have a $300,000, 30-year mortgage and your interest rate on that loan is 4.75%. That means your monthly payment for principal and interest is $1,565.

If you were to refinance that loan to a new 30-year mortgage with an interest rate of 3.25%, which is a rate you might easily qualify for today if you have a good credit score, you'd lower your monthly principal and interest payment to $1,306. That's $259 a month in savings.

At first glance, refinancing a mortgage might seem like a great option. But there's a risk in refinancing, and it's spending so much to finalize your loan that you don't actually reap any savings at all.

Don't let closing costs negate your savings

When you take out a new mortgage, including a refinance, you're required to pay closing costs on that loan. Closing costs are the various fees lenders charge to put a mortgage into place, and they include things like application fees, title searches, and recording fees.

The fees you'll pay to finalize a refinance will depend on the refinance lender you opt to work with, and it's a good idea to shop around with different lenders and compare the closing costs they quote you. But for the most part, you should expect to pay the equivalent of 2% to 5% of your loan amount in closing costs to put your new loan into place. This means that if you're borrowing $300,000, your closing costs will most likely amount to $6,000 to $15,000.

Now, let's assume that your closing costs fall on the lower end of that range so that you only end up having to spend $6,000 to finalize your new loan. If paying that $6,000 saves you $259 a month, it will take you a little over 23 months to break even -- meaning, to have saved enough on your monthly payments to cover that $6,000.

Once you're in your home for 24 months, you'll start to reap actual savings, because your closing costs will have been accounted for. But if you only end up staying in your home for, say, 18 months, you'll actually end up losing money by refinancing.

And there lies the big risk of getting a new home loan. Closing costs can be substantial, so it's important to make sure you intend to stay in your home long enough to recoup them and come out ahead. If you're unsure of your plans, it may not be worth it to refinance, even with today's rates being so attractive.

Of course, sometimes, plans can change. You might think you'll stay in your home forever only to get a great job offer across the country that requires you to relocate. But before you refinance, try to determine how long you plan to stay in your home. It could spell the difference between benefiting financially from a refinance or losing out.

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