Refinancing Your Home: Should You or Shouldn't You?

With benchmark 30-year mortgage rates dropping to record lows, homeowners across the country may be wondering whether now's the time to refinance. There are often many compelling reasons to refinance your mortgage, not the least of which is saving money on your monthly mortgage payment. However, there are also a few instances when it's not the wisest move. To help sort through it all, we asked financial experts across the country to weigh in on how to decide whether refinancing is a smart move.

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One of the most popular and logical reasons to refinance is to secure a lower interest rate, which ideally lowers your monthly mortgage payment. But just how much lower should the rate be in order to make refinancing worthwhile? "Generally, if you can decrease your interest rate by 1 to 2 percent by refinancing, it's worth it to do so, and you'll most likely save hundreds on your monthly mortgage payment," said Chane Steiner, CEO of the personal finance site Crediful.

Refinancing is typically not cheap. There are many fees and expenses associated with the process such as closing fees, and appraisal fees, which can add up to thousands of dollars. So, when considering a refinance, you'll want to weigh how much all those fees will be against how much savings you'll ultimately realize in your monthly mortgage payment. "You always want to take into account the expenses involved when doing a refinance to determine if it makes sense. For example, if closing costs are going to be $3,000 and you'll save $150 a month, you would want to make sure that you plan on being in the loan for 20 or more months as that's your 'break even' point for recouping these costs," said Ryan Leahy, a sales manager for Massachusetts-based Mortgage Network. "If it will take years to recoup the costs and there's a chance you might not be in the home that long, refinancing may not be a good idea."

Consolidating debt is another reason that Eric Jeanette, owner of Dream Home Financing and FHA Lenders says it might make solid economic sense to refinance your mortgage. In this scenario, often you borrow against the equity in your home in order to withdraw enough cash to pay off all of your debts. "In general, if the monthly payments on all of your debt combined are high (mortgage, credit card, auto loan, student loans) and some of those have a particularly high interest rate, you can consolidate it down to just one loan — your mortgage — where the monthly payment would be less than all of the individual payments you're making right now," Jeanette said. 

Interest-only mortgages allow those who might not otherwise be able to afford a mortgage payment to get into homeownership. These mortgages allow the buyer to make monthly mortgage payments on just the interest portion of the loan, not the principal. But typically, this structure only lasts for an introductory period (perhaps three to seven years), after which payments suddenly balloon to include both interest and principal. What's more, that interest rate suddenly becomes variable in many cases, says Chris Oliver, editor and partner for the real estate website Hauseit. "If you happen to have an interest-only or adjustable-rate mortgage, then the teaser interest rate you pay will typically be lower during the initial period," Oliver explained. "As a result, payments can increase dramatically after the teaser period, which means refinancing might be mandatory for some borrowers who simply can't afford higher monthly payments."

Most experts seem to agree that refinancing your mortgage to shorten its term from 30 years to 15 years can have benefits, but you need to consider this option very carefully before proceeding. "Shortening your mortgage length is a trade-off. On one hand, you'll own your house sooner and probably save a lot of money on interest payments, possibly thousands of dollars," said Steiner of Crediful. While this sounds great, it also means you'll be paying a far steeper mortgage payment every month, and if your financial situation changes suddenly, it could be that much harder to make the monthly payments. However, if you're certain your finances are on rock solid ground for the foreseeable future, then a 15-year mortgage could be a wise move. "If you have the extra money and your finances can handle a higher monthly rate, it would be well worth investing in shortening your mortgage," Steiner said. "However, if you have other debts and expenses to pay off, you'd probably be better off sticking with the 30-year plan."

Refinancing may also be a good option for some people if their financial situation has changed, meaning that they suddenly need lower monthly payments, says Guy Troxler, chief operating officer for FedHome Loan Centers. Perhaps you have a sudden salary reduction, or your other living expenses have substantially increased. By refinancing your mortgage at a lower interest rate, you'll ideally reduce the monthly payment and have more cash to cover other costs.

If you've managed to develop substantial equity in your home, it may make sense to pursue a cash-out refinance in order to withdraw some of that money and invest in other financial vehicles that will earn you even more cash over the long run. "Investing in other real estate, such as rental properties, or opening up a new retirement fund, which may be smart today with the decline in the stock market recently are among the options," said Jeanette of Dream Home Financing. "You might also want to set up a college investment fund for your kids." In other words, anything that will earn you more than allowing that cash to sit as equity in your property.

If you've been diligently working to improve your credit score and payment history, that effort may pay off in a refinance by giving you access to a lower, more favorable interest rate, which translates into a lower monthly mortgage payment. "In the event that your credit score and payment history has improved since last taking out a mortgage loan, it may allow you to qualify for better rates or even new loan programs. This can make refinancing an attractive option," said Leahy of Mortgage Network.

You don't always have to wait for an interest rate decrease in order for refinancing to be a good choice, says Leahy. "The fact of the matter is that refinancing makes sense whenever it fulfills a want or need," Leahy explained. "These examples could include a person refinancing from a 30-year loan to a 15-year loan to put them in a position to retire early or someone looking to pull equity out of their home in order to put their son or daughter through college."

If you're not planning on staying in your home for at least another few years, it may not make sense to spend the money on the thousands of dollars in fees associated with refinancing. "Since total refinance fees can be approximately 1 percent of the loan amount, those fees may outweigh the savings you can achieve through a lower interest rate if you won't be able to take advantage of that lower rate very long," said Oliver of Hauseit.

It's important to keep in mind that a cash-out refinance ultimately increases your unpaid loan balance because the cash you're taking out is added to the total mortgage balance you owe on the home, explains Glenn Brunker, a mortgage executive with Ally Home. That means it's a good idea to be sure you're using the cash wisely, for a true need, not discretionary spending. "You don't want to tap into your home's equity to finance short-term consumption. For example, if you use home equity to pay for a vacation, then you'll still be paying off that vacation long after the trip has ended. Instead, focus on good investments with long-term pay off," Brunker said. 

For those who live in a different world than Middle America, perhaps Wall Street employees, Oliver suggests that refinancing might best be avoided if you're in line for a sizable bonus that could instead be used to eliminate your mortgage altogether. "Working professionals in many fields such as finance in New York City receive much of their pay in the form of year-end bonuses. If you do get a big bonus, you may not know what to do with it. For example, you might not be sure whether it's a good time to put money into the stock market," Oliver said. "As a result, you may wish to opt for the sure thing and reduce your mortgage debt instead…Bonuses on Wall Street and other fields can be big enough to pay off an entire mortgage."

Some of the other scenarios under which you may want to hold off on refinancing include having bad credit, or having very little equity in the property you are seeking to refinance, neither of which would likely provide favorable refinance terms. "In a general sense, no matter how enticing a home refinance is, everybody should run the numbers and figure out if refinancing will save them or cost them not just in the short term, but in the long term," Steiner said.

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