The Lure of Lower Payments – When Should You Refinance?

Mortgage brokers will always tell you they can lower your monthly payment.  And sure, sometimes they actually can.  But is it worth refinancing, even then?

Refinancing is not something to take lightly.  For starters, the up-front costs are extremely expensive, costing upward of $3,000 on average.  Can you think of a few things you’d rather do with that money?  I can.  (And they don’t involve handing it to a bunch of 25-year-old mortgage bankers to blow on a wild weekend in Vegas.)

So your first question must be “How many years will it take me to recover the closing costs of the refinance, in monthly savings?”  The answer probably won’t make you happy.

But that’s just the tip of the iceberg.

Consider next that each month that goes by in your current loan, a higher portion of your monthly payment goes toward paying down your principal balance.  I know, I know, “not more math!”  But it’s important to understand what’s called “simple interest amortization.”

The first payment of any mortgage is always the worst: most of the payment goes to interest for the bank, and a tiny fraction goes toward paying down your principal balance.  The next month, slightly less goes to interest, and a little more goes toward principal.  This change is gradual at first, then starts picking up speed around halfway through your loan.  Around three quarters of the way through your loan, there’s an exponential shift, and this is when you really start paying off your loan.

Banks never, ever want to see borrowers get to this point in their mortgage payments.  They want you to keep refinancing, so that they can charge you more up-front fees, but also to keep your monthly payment mostly interest.  It’s in the bank’s best interest (no pun intended) to keep refinancing you, so that you never get far enough into your loan to really start paying down your balance.

So, the further you get in your loan, the more aggressively they’ll push refinance offers on you.

“But what if I want to borrow more money?”

I’ll spare you the lecture on borrowing money for non-essential things like vacations or a new bathroom.  If you really want to borrow money, consider some alternatives: home equity lines of credit, second mortgages, personal loans, friends and family, peer-to-peer loans, crowdfunding websites, even low-interest credit cards.

If your original mortgage was a good one, it almost never makes sense to refinance.  When you do, you start over at the beginning of your principal/interest ratio, and extend your debt even further into the future.

A good loan is a low-interest, fixed-rate mortgage, for a term (15-30 years) that makes sense for your financial goals.

But what if you got a bad loan?  A high-interest loan, or an adjustable rate mortgage that just spiked?

Then, and only then, it might make sense to refinance.  Still, you’ll need to look closely at how long it will take your monthly savings to justify the cost, and at how much longer you’re extending your debt.

Remember that loan officers are salespeople.  They are trying to sell you something – in this case, more debt.  Like nuclear reactors, debt can be a useful tool, but it’s also extremely dangerous.  Always get the right mortgage when you first purchase, because refinancing later is very, very expensive.♦

Care to weigh in? We always love fresh voices and a healthy splash of argument…

Related Reading:

Unconventional Financing Part 3: Hard Money Loans