Does It Make Sense to Refinance?

Does it make sense to refinance right now? With mortgage rates still quite low, this question comes up a lot, along with online calculators and columnists advising how to answer it.

It seems like a simple enough question. If you are currently borrowing at X%, and you could refinance at Y%, and Y% < X%, wouldn’t you want to do it? As most people know, the answer isn’t that simple.

Two Complications to the Question

The first complication to the refinancing question is closing costs. It’s expensive to take out a new mortgage, especially with a new lender. (If your existing lender will simply lower your rate for no closing costs, no new title insurance, and/or a nominal fee, it makes the calculus much easier.) Closing costs can include title insurance and title fees, local government filing fees, state taxes on the note or mortgage, extra escrow for taxes and insurance, plus points and nonsensical miscellaneous fees charged by the lender. It’s hard to discern which of the closing costs should be considered in the comparison and which should be left out.

The second hurdle is the reamortization of your debt. Why does this matter? In a mortgage amortization, payments in the beginning are mostly going toward interest. You may have noticed that it takes a while before your payments start making a meaningful dent in the principal balance. The longer you hold a mortgage, the more of your payment is going toward principal. When you refinance, even if you don’t take on additional debt, you are starting over on your amortization of principal and interest. You lose that momentum toward principal repayment that you gain every year with your existing mortgage.

Refinancing Approvals After Retirement

For those who are retired, the mortgage approval process can be a bit more cumbersome, because underwriting a mortgage tends to give more credit for high income than for high assets in a retirement account. Here is a helpful article from a realtor that addresses this issue: https://www.sandyhartmannhomes.com/blog/How+To+Get+A+Home+Loan+After+You+Retire

Ask Yourself Why You Want to Refinance

This brings us to the whole purpose of refinancing. What is your main goal? Is it to save on monthly payments, finance a home improvement, or increase your long-term wealth?

My suggestion is that refinancing simply to save on monthly payments should only be done in a cash-flow-critical situation. Unfortunately, the save-on-your-payments question is the one answered most commonly by online calculators.

The best argument for refinancing is to increase your long-term wealth. It’s been hard to find an online calculator that helps with this particular question, so here’s a homemade one: https://www.hollydonaldsonfinancialplanner.com/wp-content/uploads/2021/07/Hollys-Refi-Calculator.xlsx

Disclaimers

My homemade calculator is not perfect. In fact, it’s pretty ugly as calculators go. I’m no graphic designer. Some caveats: It doesn’t compare an adjustable rate mortgage to a fixed one (I don’t know who could – how do you know what the rate will be in 5 or 7 years on an adjustable?) And, it assumes a flat 2% for closing costs (but you can put in your own, if you know which ones to count and which ones to leave out.)

If you know of a better one, I’d love a link to it – please post in the comments. Or, if you want to download mine and improve it, even better. Either way, remember when it comes to refinancing, it’s all about asking the right question.

Holly Donaldson

Holly P. Donaldson, CFP® writes and consults on the psychology of money. Her fee-only, product-free financial planning practice focuses on increasing financial self-efficacy for those seeking a financial navigator to help them make good decisions. She is the author of The Mindful Money Mentality: How to Find Balance in Your Financial Future (Porchview Publishing, 2013) and publisher of the award-winning monthly e-letter, "The View From the Porch." With a fully virtual practice in Seminole, Florida, she primarily serves clients located in the Tampa, St. Petersburg, and Clearwater areas. Holly will also work with clients who are a good fit located elsewhere in the United States.

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