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With all this talk about the Federal Reserve Board dropping the federal funds rate later this week, a lot of people have naturally turned to the idea of refinancing their mortgages. And while it's not a wrong move for someone, a refinance is not the end-all-be-all solution that a lot of people believe them to be.
In fact, if you're only chasing mortgage rates , you may end up paying a lot more for your home by refinancing multiple times, or at the wrong time, depending on your wider financial picture.
Here are two situations in which you should not be considering a refinance in September.
1. You plan on moving in the short term
Although homeowners are staying in their homes a lot longer than they used to, 11.9 years on average, you still probably won't save money on a refinance if it's not your forever home. This is because there are significant costs associated with refinancing your mortgage, plus your mortgage interest is front-loaded, so you'll be paying that twice.
Your mortgage lender will be able to give you a more precise figure, but you can count on paying anywhere between 2% and 5% of the new loan balance in fees on refinance closing day. You may be able to roll these expenses into your mortgage, but then you'll have to pay interest on the fees, increasing their costs.
Let's say you bought your house in November 2022 with a 7% interest rate and you paid $400,000 for it. With a 10% down payment, you borrowed $360,000. Your principal and interest (P+I) payment has been $2,395 since then. If you choose to refinance at the end of 2024, you still owe $352,082 and have paid $51,959 already in interest. It will cost you an additional $17,000 to refinance the loan.
In our scenario, the Federal Reserve really takes a big whack at interest rates and mortgage rates drop to 5.5% by the end of the year. This means the new loan will have a payment of $1,999, and your breakeven point to cover the cost of refinancing it will be in 43 months
But let's talk about interest. If you plan to move at the end of 2028, just beyond your refinance breakeven, you're still going to be upside down in the deal. If you refinance and sell at that point, you've spent about $52,000 in interest on the first loan, $17,000 to refinance, and just over $73,000 in additional interest, for a total of $142,158 in interest and fees.
If you'd stayed with your original loan, you paid only $98,672, even though your interest rate was higher. Knowing that you were going to move in a few years means you'll never be able to reap the full benefits of a refinance.
| Original Loan | New Loan |
|---|
| Balance | $360,000 | $352,082 |
| Interest rate | 7.00% | 5.5% |
| Current payment | $2,395 | $1,999 |
| Interest paid prior to refinance | N/A | $51,959 |
| Cost to refinance | N/A | $17,000 |
| Original interest paid to 2024 | $98,672 | N/A |
| New interest paid to 2028 | N/A | $73,199 |
| Total cost of mortgage | $98,672 | $142,158 |
Data source: Calculations by author.
2. You've already paid down a significant chunk of your note
For whatever reason, instead of just making your regular payment, you've been paying extra -- maybe a lot extra -- and you've managed to reduce your young mortgage balance significantly. Again, the most likely time you purchased your home if you're considering a refinance was some time in the last two years, so let's use November 2022 again.
If you really hustled and paid an extra $1,000 per month on top of your base mortgage payment of $2,395 for the first two years of ownership, you'd have quickly knocked your principal down to just $326,741 and saved yourself close to $4,000 in interest. You did well.
But if you refinance at this point, even if rates are really great, you're still going to incur about $16,000 in fees, the original $48,000 in interest you paid, and the interest for the rest of the new loan if you pay it in full.
All and all, you're $33,901 behind because you refinanced to a lower rate. I know it's counterintuitive, but unless you need a smaller payment, rate is not the only thing that matters. You'd be better off to divide that extra $34,000 up over the remaining payments and pay down your principal early.
| Original Loan (November 2022) | Loan After 24 Payments w/ Extra Payment Included | Refinanced Loan w/ Extra Payments Starting Year 3 |
|---|
| Balance | $360,000 | $326,741 | $326,741 |
| Interest rate | 7.00% | 7.00% | 5.5% |
| Current payment | $2,395 | $2,395 | $1,855 |
| Extra payment | N/A | $1,000 / month | N/A |
| Interest paid to 2024 | $51,959 | $48,223 | N/A |
| Cost to refinance | N/A | N/A | $16,337 |
| Interest paid for first 24 months | N/A | $202,554 | N/A |
| Interest paid for mortgage lifetime | $502,232 | $371,790 | $341,131 |
| Total cost of note if paid in full (interest + fees) | $502,232 | $371,790 | $405,691 |
Data source: Calculations by author.
There are countless reasons to not refinance
Due to the limitations of space, I couldn't go into every reason to not refinance in September, or beyond, but these are a few of the most common situations where you'd be worse off if you refinanced. Remember, interest rate is just one number, and to see how much your mortgage and your refinance really cost, you have to look at all your expenses.
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