When is it the smart play to refinance your home loan?

These days, it’s impossible to ignore all of the chatter about low interest rates, lower interest rates, and, by the way, the Fed just dropped rates again. With that comes a landslide of refinancing as homeowners try to save a few bucks by grabbing a home loan with a lower rate (and payment) while the savings still last.

But, if you refinance now, will it be the smart play or a short-sighted move?

In case you are unsure, a refinance is merely a home loan that replaces an existing home loan, often times the original loan used when purchasing the home. The outstanding balance still owed on the existing home loan is paid off by the new refinance loan. It may be for the exact amount of that payoff (plus some fees), called a Rate and Term refinance, with the benefit being to save on your monthly payment with a lower rate.

Or, you may look to cash in on your equity and receive some money in hand when you refinance, called a Cash Out.

Either way, there is some financial benefit to the homeowner, like saving money on the monthly payment, getting a few bucks in pocket, and secondary pluses like removing mortgage insurance, fixing an adjustable rate loan, or shortening the payoff of the loan.

But it doesn’t always make dollars and sense to refinance, as it may be Fool’s Gold for a number of homeowners under certain circumstances.

Like anything, there’s a time and a place for refinancing, as it’s a viable, money-saving financial tool for millions of Americans. But, there are times when it actually won’t be the smartest move, too.

Let’s look at both!

And remember that the best way to save money – whether it be through a refinance, lowering your credit card payments, or qualifying for any savings with debt – is by keeping a great credit score.

When is refinancing the smart play?

At first glance, the benefit to refinancing looks pretty apparent: you’re swapping out a higher interest rate with a lower one. Refinancing into a new mortgage with a 4.5% interest rate (just for purposes of our illustration) when your existing home loan is a 5.7% rate will lower your monthly payment. Quite simply, that’s the chief reason the majority of homeowners refinance.

But, aside from just the monthly payment, the more important number is the total payoff, which includes all interest and principal you’ll be paying to get to zero on your mortgage balance. By lowering your interest rate with a refinance, you’ll drop the amount of interest that you owe the bank, which is a glaringly big cost. In fact, on many home loans, a $300,000 loan balance may actually cost you $500,000 – $700,000 in total payoff!

So, don’t just check the monthly payment to see if refinancing makes sense, but compare your current total payoff against the proposed payoff of a refinance. Usually, there will be a lot of savings, but that’s not always the case (see below).

Likewise, another huge benefit to refinancing is setting an adjustable rate loan to a fixed rate. For instance, with a 30-year fixed loan, you’ll have the same stable payment based on the same starting interest rate for 360 months, until you pay off the home.

However, there are a lot of adjustable rate loans on the market. Adjustable rate loans have a set interest rate (and payment) for a certain period of time, like 3 years, 5 years, or 10 years, etc. But, after that initial set period expires, the interest rate is adjustable (monthly or yearly). The rate will be based on a certain financial index, but the point is that it can go up or down (but, especially up) erratically, blowing with the winds of the financial climate. So, that nice low monthly payment when you first got your Adjustable Rate Mortgage (ARM) loan, may go away for a significantly higher payment down the road – sometimes shockingly high!

Therefore, many people with ARM loans refinance into a 30-year fixed loan with a low interest rate that will also be stable over the entire loan term, not fluctuating at all.

Of course, many homeowners want to refinance to get some money out of the homes, cashing out some of the equity they’ve accumulated. Does this make financial sense? There are countless articles and even books that discuss the pros and cons of cashing out equity, but the point is to use the equity for your financial benefit – like paying off high-interest revolving credit card debt, etc. that puts you in a better fiscal situation. Again, remember to keep your credit score high if you want to refinance and also to get lower credit card rates!

Down the line of benefits to refinancing is the ability to get rid of MI, or mortgage insurance. However, there are other ways to drop MI from most loans (with enough accrued equity), so check with your mortgage broker first.

When does it NOT make sense to refinance?

Ok, let’s look at the flip side of this money-saving refinance.

Refinancing isn’t free, and with any “refi” comes a whole lineup of fees and charges. Some of these are to your mortgage broker or bank; some to the title companies; and others for prepaid interest and insurance, etc. Either way, fees for a refinance can easily add up to 1-3% of the entire loan amount, which may add up to $3,000 t0 $9,000 for a $300,000 home loan (as a super rough estimate).

So, you’ll have to factor those fees and charges into your proposed loan when you are considering the option of a refinance. Of course, the better your credit score, the lower interest rate you should qualify for, so the best way to cash in and save with a money-saving interest rate is by keeping a great credit score.

Do the math: if a refinance saves you $300 per month but costs you $6,000 just in fees and charges at the end of the day, that means your real savings won’t come until after the first 20 months of the loan.

And if you’re only saving $150 per month but the refinance will cost you that same $6,000, you may want to rethink the benefit.

Likewise, if you have a prepayment penalty on your existing home loan, a huge fee may be hanging over the loan, making a refinance a non-starter once you factor in that cost.

A refinance may also not make sense if you plan on selling your home in a few years. For instance, if the kids are in high school but going off to college in a few years and you think it will be time to sell and downsize then, why bother refinancing?

Needless to say, if your credit score isn’t up to par, you may not qualify for the best interest rates and programs, so a refinance might not make sense (at least, until you fix your credit score, first!).


The bottom line is that every situation, every homeowner and every home loan is different, so there’s no one correct answer to answer the question, is it a good idea to refinance?

Talk to a great mortgage broker who can pencil out the different scenarios with you to make sure a refinance is the best option, and contact Blue Water Credit well ahead of time to ensure your credit score is healthy so you will qualify for the best possible refinance available!

Contact Blue Water Credit today to start any refinance process with a quick credit score check!