- Business Insider spoke with Darrin English, senior community development loan officer at Quontic Bank, about when it might be a bad idea to refinance your mortgage.
- English said you probably don't want to refinance if you won't save enough to offset closing costs within the first 2 1/2 years.
- Certain strategies for lowering your monthly payments, such as refinancing to a longer term or switching from a fixed to adjustable rate, could cost you more in the long run.
- Refinancing to use the cash for unnecessary purchases or to invest in the stock market may not be the best idea, and refinancing to offset loss of of income due to the coronavirus might not work out.
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There are plenty of reasons to refinance your home — better rates, lower monthly payments, and getting rid of private mortgage insurance are just a few of them.
But there are times when refinancing isn't the best financial decision. Darrin English, Senior Community Development Loan Officer at Quontic Bank, spoke with Business Insider about what some people think are "good reasons" to refinance — but in reality, are rarely the best idea.
- 1. To lock in a rate that's only a fraction of a percentage point lower
- 2. To move into a longer-term loan
- 3. To switch from a fixed-rate mortgage to an adjustable-rate mortgage
- 4. To invest money in the stock market
- 5. To spend cash on unnecessary purchases
- 6. To offset financial losses from the coronavirus
1. To lock in a rate that's only a fraction of a percentage point lower
Just as with your initial mortgage, you'll have to pay closing costs when you refinance your home. Closing costs typically amount to thousands of dollars.
If you're chasing a new rate that's a fraction of a percentage point lower than what you're currently paying, then it could take you a long time to save enough to offset the closing costs.
Homeowners in New York and California should also factor in the states' mortgage taxes.
"New York and California are the only two states in the nation that have a mortgage tax," English said. "If you're borrowing $500,000 or less, you're going to be required to pay the state 1.8% of the amount that you borrow. If you're borrowing more than a half million dollars, then you're required to pay the state 1.925% of the amount. So your closing costs can be considerable."
English said the rule of thumb is that you should only refinance if your new rate will be at least 1% less than what you're paying now. Another way of looking at it is that you should be able to break even within 2 1/2 years.
"This was actually a Housing and Urban Development rule at one point, and it's become the standard," English said. "I've been in the business for almost 25 years now, so I just hold it as true, because I've seen success."
2. To move into a longer-term loan
If you only have 20 years left on your mortgage, for example, it may seem like a good idea to refinance into another 30-year mortgage. By stretching your remaining payments out over a longer period of time, your monthly payments will be lower.
But English usually doesn't recommend this strategy, especially if you plan to stay in the home long-term. You'll be making payments on your home for longer, and you'll end up paying more in interest by extending your loan term.
"If you're considering paying off your home as part of your retirement plan, it's probably not a good idea to create a brand new 30-year mortgage," he said. "It's always better to either maintain your current payment — or if you're going to refinance, to refinance into a lesser term. Consider a 15-year, especially if the rate is low enough where you can keep the monthly payments almost close to what you're paying, and reduce the term. You'd be better off."
3. To switch from a fixed-rate mortgage to an adjustable-rate mortgage
When you apply for a mortgage, you choose between two basic types of loans: fixed-rate mortgages and adjustable-rate mortgages, or ARMs.
Fixed-rate mortgages lock in your rate for the entire life of your loan, and ARMs lock in your rate for the first few years, then change your rate periodically.
Adjustable rates typically start lower than fixed rates. So you may be tempted to refinance from a fixed-rate mortgage into an ARM so you can score low rates for the first five, seven, or 10 years, and have lower monthly payments in the short-term.
"I would never suggest refinancing out of a fixed-rate mortgage into an ARM just to reduce the monthly payment," English said, "simply because even if it's fixed for a period of time that you can measure, you don't really know where the economy will be once that loan begins to adjust."
By refinancing into an ARM now, you risk paying more later.
4. To invest money in the stock market
Maybe you want to refinance so you can either a) cash out and invest the money in the stock market, or b) make lower payments and invest the monthly savings into the market.
"I really wouldn't recommend that," English said. "Is there ever a time? Sure. But would I recommend it? Absolutely not. The stock market, much like real estate, is cyclical. And there are things that you just can't predict."
"So will it outperform your home?" he continued. "It's all based on jurisdiction. If you lived in New York in 2006, when we were at the beginning of a new real estate cycle, you could have bought a two-family home in a prime area of Brooklyn, say Bedford-Stuyvesant, for $525,000. That same home now is worth almost $2 million. If the money is put into really low-risk stocks, could you outperform real estate? I can't say you will."
5. To spend cash on unnecessary purchases
If your home has gained value since you bought it, a cash-out refinance could be a good way to tap into your home equity and pocket money for other expenses. But you should think carefully about which costs are worth refinancing and which aren't.
"If you're going to cash out to consolidate debt — lowering your monthly payment by way of spreading out the amortization over 30 years and reducing the interest rate — then by all means, a cash-out makes sense," English said. "If you're looking to invest in another home that will outperform its current placement, then absolutely. If you're just looking to go away or do something frivolous, it's probably not the best way to spend your hard-earned equity."
Ultimately, it's up to you whether an expense constitutes refinancing. Just be sure to weigh the pros and cons.
6. To offset financial losses from the coronavirus
If your finances have taken a hit during the coronavirus, you may be thinking about refinancing to cut costs. The only problem is that it might not be possible. If you've already lost income, your lender probably won't approve your application.
English said refinancing could be the right move if you suspect you will lose income soon, though.
"If you're looking to bolster your savings and cut down on expenses, this might be the absolute best time to do it," he said. "Especially if you think your job is going to furlough you."
But if you think your job could furlough you before you close on your new loan, it's probably already too late to refinance. You need to still have a steady income until the refinancing process is complete.
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