When Refinancing Your Mortgage Could Actually Cost You Money

Refinancing has been a popular activity for homeowners since that pandemic began. In fact, 2020 saw the highest volume of mortgage refinance originations of all time, and at their peak, applications to refinance were up 122% from the year prior.

The reason? Low mortgage rates.

Mortgage rates declined for a large part of 2020, eventually hitting a record low of 2.65%. Those rates offered a serious incentive for millions of homeowners to refinance. Many were able to both lower their monthly payments and reduce the long-term interest costs of their loan (often by tens of thousands of dollars — or more).

But those record-setting days are ending, and mortgage rates have started trending back upward. Currently, the average rate on a 30-year mortgage loan is 3.18% — up nearly half a percentage point since just January.

That jump — coupled with rising closing costs — has made refinancing less attractive than it was a year ago. According to the Mortgage Bankers Association, applications to refinance are now down 20% compared to the same point in 2020.

In some cases, the savings just aren’t there (or not significant enough). In others, refinancing may be a poor decision because of prohibitive costs, low credit or just plain bad timing. Are you currently mulling the idea of a refinance despite today’s rising interest rates? Here are six times you might want to steer clear of one — or at least think twice before you pull the trigger.

Interest rates are higher than what you have now

This is the big one. If you’re hoping to save money, then it’s critical you get a loan with a lower interest rate than what’s on your current mortgage.

According to David Steinmetz, division president of origination services at mortgage technology firm ServiceLink, a 1% reduction is a good goalpost. “If you can’t get a rate at least 100 basis points off your current rate, it may not make sense,” Steinmetz says.

Jess Kennedy, co-founder and chief operating officer at Beeline Loans, however, says even a quarter or half of a percentage point can offer big savings for some homeowners.

This is still plenty possible for many homeowners — despite rising interest rates. Case in point: Today’s rate of 3.18% is well below what even the most qualified borrowers were getting just two years ago. In March 2019, the average mortgage rate was 4.27% on 30-year loans. A decade ago, it was almost 5%.

For homeowners stuck with these rates, refinancing at today’s averages — though higher than they were a few weeks ago — could certainly save cash, both monthly and over time.

Your credit isn't great

Homeowners with less-than-stellar credit may want to think long and hard about a refinance, too.

“If you have a poor credit score, you’ll want to hold off on refinancing because you may not be able to qualify for better mortgage rates,” says Mark Reyes, a certified financial planner for personal finance app Albert.

A good number to shoot for? Reyes recommends at least a 700 if you want a good interest rate, but “the higher, the better,” he says. The best mortgage rates generally go to people with scores of 740 or above.

“Even the difference between a 700 score and a 660 score could mean a half-percent to 1% difference in interest,” Reyes says. “That may not seem significant at first, but a 1% higher rate on a 30-year mortgage could cost you tens of thousands over time.”

To be clear: Homeowners with lower credit scores won’t find it impossible to refinance their mortgage. Every lender has different credit score criteria, and many offer low-credit loans, too. These just come with higher interest rates than what better-credit borrowers receive — and that could mean forgoing savings that might be within reach.

A better option than eating those higher rates? Work on your credit.

“When you have a low credit score and are looking to refinance, your best course of action is likely to spend some time paying off debts and paying your credit card off on time,” says Dan Holtz, CEO of Sovereign Lending Group in Orange County, Calif.

You might move in the next few years

You don’t need to live in your “forever” home to benefit from refinancing, but your long-term plans for the house should definitely play a role in your decision.

That’s because refinancing — just like your initial mortgage loan — comes with closing costs. Lately, these have come in somewhere around $3,400 for a refinance, or about 2% to 5% of the total loan amount.

“Consider how long you expect to be in your home,” says Andrew Westlin, a certified financial planner at Betterment, an investing and saving app. “Will you be there long enough for the interest savings to offset the cost of the loan? If not, refinancing isn’t necessarily a good idea.”

The best way to determine if refinancing makes sense is to calculate the breakeven point — or the number of months it will take to recoup your closing costs. If you plan to stay in the house that long, then refinancing might make sense. (To determine your breakeven point, divide your estimated closing costs by your estimated monthly savings.)

“Homeowners should do the math to see if refinancing is worth it for them based on how long they plan to be in the home,” Steinmetz said. “It doesn’t have to be your forever home for the costs to pay for itself, but most times, you’ll need to plan to stay for a while. If you’re unsure, it may make more sense to wait it out until you’ve decided, so you don’t wind up paying more in the long run.”

On the other hand, if you plan to live in your home for the long haul (and you’re comfortable there won’t be job or family changes that force you to move down the road), Kennedy says the choice is much clearer.

“If you’re loving where you are and aren’t planning to move anytime soon, the decision to refi is a pretty easy one,” she says.

You just bought your home

If you recently purchased your home, refinancing could make financial sense, but not always. For one, you’ll need to pay closing costs again — something you might not have cash for if you just bought the house.

There are also prepayment penalties to think about. When you refinance, you’re really paying off your existing loan and taking out a new one. Some mortgage loans charge penalty fees if you pay off your loan within the first few years — typically somewhere between 1% and 2% of your total loan amount, depending on when you pay off the balance.

“You’ll want to make sure that your mortgage company does not have any prepayment penalties and when a prepayment penalty can be waived,” Reyes says. “Some mortgage lenders may let you refinance as early as six months after you purchase your home, while others will only allow you to refinance after a full year.”

If there aren’t prepayment penalties and you can shave a good amount off your interest rate, then timing doesn’t matter so much.

As Balenda Hetzel, regional manager at Inlanta Mortgage in Destin, Fla., puts it: “It’s not a bad idea to consider refinancing a home even one or two years after a purchase, depending on what the market was doing when the home was purchased and what it’s doing now. A refinance might be a good idea if a homeowner is likely to remain in the home for a few years, and interest rates have dropped, home values have increased or both.”

You don’t have the cash for closing costs

According to closing data company ClosingCorp, closing costs average just under $3,400 per refinance — and in some places, they’re as much as $13,000 per mortgage (hello, D.C.!)

If you’re going to refinance your mortgage loan, then being able to afford these costs comfortably — i.e., not draining your bank account to cover them — is critical.

Though many lenders advertise what’s called a “no closing cost” mortgage, these technically just let you finance the charges. While this removes the need for upfront cash, it also results in more interest paid over time. On a $200,000 purchase balance with a 3% rate, for example, rolling an additional $6,000 in closing costs into your loan would result in an extra $3,000-plus in long-term interest.

“When rolling closing costs into the loan, those costs are subject to interest and will end up costing the borrower much more than if they are paid out of pocket to begin with,” says Dan Bailey, senior vice president at WFG Lender Services, which provides settlement services to lenders across the country. “This may be acceptable for a borrower who is only concerned about saving in the short term but probably makes less sense for a borrower in their forever home.”

In some cases, lenders will allow you to waive your closing costs in exchange for a higher interest rate. This would mean more interest paid over the life of the loan, and it could reduce how much your refinance stands to save you.

“Just because there are no upfront costs does not mean your refinance is free,” Westlin says. “In this case, you are just kicking the can down the road. You are borrowing to borrow.”

You’re close to retirement

If you’re nearing retirement, refinancing your home could be a way to lower your monthly payment and free up cash — a big perk if you’re on limited income. You could also refinance into a shorter-term loan, allowing you to pay off the mortgage and become debt-free sooner.

But there are downsides to refinancing at this stage, too — especially if you’re choosing a lengthier loan term.

Remember, refinancing resets the clock on your loan. As Westlin puts it, “While you may have lower payments, you will be making payments later in life if you extend the term of the loan. You need to make sure that your savings, Social Security and other income sources can sustain those payments over time.”

Applying for your refinance during retirement could also make it harder to get a good rate. If you’re not bringing in much cash and your ratio of debt to income is high, you may be seen as more of a risk to lenders — and that means a higher interest rate and more in long-term costs. (That said, it is illegal for lenders to base credit decisions on your age.)

Still, the decision isn’t always clear. According to Holtz, the best option is the one that improves your overall retirement plan — and that will vary widely by person.

“Is the rate materially lower than they currently have?” Holtz asks. “Does it lower their monthly payment? Are they planning to move soon to downsize?” These are all questions you should answer before refinancing close to retirement — and if you’re not sure, consider talking to a financial advisor to be safe.

Refinancing might still be smart

It’s true: Rates are on the rise. But for many homeowners, today’s rates are still much lower than what they’re currently paying. In these scenarios, refinancing can still be a smart move.

“Rates are still historically low,” Kennedy says. “If your current interest rate is higher than a rate you can get today by about a quarter to half a point or more, it’s worth looking into a refinance.”

Remember, though: Reducing your interest rate and saving cash also aren’t the only reasons to refinance. You can also refinance to get rid of mortgage insurance, change the length of your loan or switch from a variable interest rate to a fixed one. Cash-out refinances are also an option — especially with today’s rising home values.

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