Personal Finance

When It’s Worth It to Refinance and When It's Better to Leave Things Alone

By Bethany Hickey

Mortgages, auto loans, student loans — we’re often bombarded with refinance offers that advertise savings. Refinancing can be tempting, but it’s not the best idea all the time.

Refinancing changes up your loan

Refinancing involves replacing a current loan with a new loan, usually to save money by getting more favorable rates and terms. When refinancing a mortgage, you can change things up even more like switching from adjustable rate to a fixed rate, or go with a cash out refinance.

But depending on how you go about refinancing, it could mean either saving or paying more long term. 

Here are some typical fixed-rate refinancing changes and the effects: 

  • Longer term. By just lengthening your loan term you get smaller monthly payments. But you’ll pay more in interest charges because your rate is the same. You’re taking longer to pay off the loan and allowing more interest to accrue.
  • Shorter term. Speeding up your loan term means you’ll save money on interest, but you’ll have larger payments.
  • Shorter term with lower rate. This is the ideal way to refinance and could save you the most money. You’ll save on accrued interest by lowering the rates and paying the loan off faster.
  • Lower rate. By just getting a lower interest rate and keeping the term the same, you’ll save money on interest charges and likely have a smaller monthly payment.
  • Higher rate. If you apply for refinancing and only qualify for a higher interest rate and no other changes, it’s better to just walk away from that offer — you’ll just pay more.

When refinancing is actually worth your time

Trading in your loan makes the most sense under these circumstances.

Rates are low

When the prime rate is low, lenders will offer lower interest rates. This increases your chance of getting a lower interest rate than you’re currently paying. Refinancing is most worth your time if you have a high interest rate on your existing loan and you want to save money long term.

For mortgages, anything above 7% is usually considered to be a high interest rate. A high auto loan rate is anything above 10% to 14%. For student loans, any rate above 5% is high. 

If your loan’s rates are significantly higher than those rates, it might be time to consider refinancing — especially if the prime rate is low and lenders are offering competitive deals.

Your credit score has improved

If you’ve done the hard work of improving your credit score, then refinancing could mean qualifying for lower interest rates. Your credit score is one of the most important factors in determining what rates you can get with nearly any loan type.

You’re struggling to repay your loan

If you need more wiggle room in your budget, refinancing could help. Refinancing a loan with a high monthly payment can be well worth your time if you want to avoid missing payments that can lead to default.

You could lower your payments with a lower rate or lengthening your loan term. But just stretching your loan term means paying more over time — something to keep in mind.

When to hold off on refinancing

Regardless of why you want to refinance, timing is crucial. Refinancing isn’t always the best move.

Rates are high

When interest rates are high everywhere, this means you might not get a lower rate — even if you have an excellent credit score. This is especially true with mortgages, and there are many different ways to refinance a mortgage. 

In 2020 and 2021, mortgage rates were historically low, around 2% to 3%. Freddie Mac reported the lowest rate on a fixed-rate mortgage was 2.65% in January 2021.

But as of January 2023, the average rate on a fixed mortgage is 6.56%. If you got your original mortgage for a rate less than 6%, then it may be better to simply wait until rates go back down, which some experts are predicting may happen this year. Nadia Evangelou, economist and director of forecasting at the National Association of Realtors, forecasts that rates will be below 6% by mid-2023.

Your credit score is the same or worse

If your credit score has decreased or stayed the same, refinancing can be a waste of time, effort and money. To be clear: Just because your credit score isn’t perfect it doesn’t mean you’re out of the running for refinancing.

But if your goal is to get a lower rate than what you have now, you’re likely going to need a better credit score to qualify those competitive rates. This also applies if your credit score has stayed the same because you may just qualify for the same rates again.

You’re near the end of your loan

Refinancing a home near the end of its loan could set you back. Towards the end of a mortgage, the majority of your mortgage payments are going toward your principal. If you refinance, you’re right back to the majority of your payments going toward accrued interest.

It may also be wise to hold off on refinancing a vehicle if you’re near the end of the loan. New vehicles lose value very quickly, usually around 20% within the first year, and many lose around 60% of their entire value by the fifth year of ownership, according to Kelley Blue Book. The longer you owe money on a vehicle, the more at risk you are for being stuck with an upside-down car loan. 

You have federal student loans

It’s usually not the best move to refinance federal student loans, especially with President Biden’s student loan forgiveness program in mind. This program may get you up to $20,000 in loan forgiveness for federal loans — but you’re ineligible for that program if you’ve refinanced them.

Even without that program, federal student loans generally have more favorable terms than private loans. They're eligible for more flexible repayment plans, like payments that increase over time or income-based plans. And if you work in public service for 10 years, you could qualify for full forgiveness.

Refinancing can be great — sometimes

When you’re looking to refinance anything, consider the timing and your credit score.

The ideal time to refinance is when your credit score is above 700 and rates are lower than when you originally got the loan. And with homes and auto loans, it’s usually better to refinance earlier than later. 

Look at all the angles, crunch some numbers, play around with amortization calculators and watch interest rates. If refinancing costs you more in the long run, it’s probably best to hold off.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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