Suze Orman Doesn’t Want You to Make This Refinance Mistake

Photo to accompany article about a refinancing mistake that Suze Orman warns readers to avoid
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Historically low mortgage rates have driven a surge in refinancing this year. If you have the financial profile to qualify for the best refinance rates, it can be a great move.

But before you jump into a refinance, Suze Orman has some advice you should consider.

If it’s going to put you behind on paying off your mortgage, consider how much you’re really saving. 

For example: If you have 22 years left on a 30-year mortgage, and you refinance into a new 30-year mortgage, you’ve just added eight years to your timeline of paying off your home. Being strapped with a mortgage for an additional eight years can outweigh the benefits of a lower interest rate.

“Do not refinance for more than the length of your term that is remaining on your mortgage,” wrote Orman, the well-known personal finance expert, host of the podcast “Women & Money,” and a contributor to NextAdvisor.

This rule won’t hold up for every individual situation, but it underscores an important point: When it comes to refinancing, interest rate isn’t the only thing that matters. 

Does Refinancing Make Sense For You?

Refinancing has the potential to save you a year’s salary or more in interest. But you have to go about it the right way, and that means running the numbers for your own situation.

Let’s take Orman’s example of a 30-year mortgage that’s been paid down for eight years. The median home for sale in the U.S. is listed at $349,000, and the average down payment for first-time homebuyers is around 6%. With a 30-year loan at 4.5% interest, you’d owe about $439,000 in principal and interest over the final 22 years of the loan, according to the NextAdvisor mortgage calculator

If you refinanced down to a 3.5% interest rate on a new 30-year mortgage, your monthly payments would go down by $400. But you’d pay an extra $10,000 in interest over the life of the loan. Instead of the $439,000 you had remaining on the original mortgage, you’d now be on the hook for $449,000 for the new refinance mortgage. 

Years left to payInterest rateMonthly paymentTotal remaining principal and interest dueClosing costs (approx.)
Original Mortgage 224.5%$1,662$439,000n/a
New Refinance Mortgage303.5%$1,248$449,000$15,000 

Paying $400 less each month, it would take you 25 months to erase the extra $10,000 of the new loan. Also, closing costs on any refinance could cost about $15,000, which would take about 37 months to offset. So now it will take you 62 months, or 5 years, before you come out ahead in the math. 

If you’re disciplined about saving and investing with your lower monthly payment—or using the opportunity to pay off other debt—refinancing might still be a smart move. But as Orman suggests, take into account any extra years you’re adding to your mortgage and how those will add to your overall costs.

Consider, too, the time you’ll take to become debt-free on your home. When it comes to budgeting, being totally free of a mortgage payment will unlock big opportunities to save, invest for retirement, and enjoy your money. 

Refinancing to a Shorter Term

On the other hand, refinancing into a shorter-term mortgage can be an unequivocal win.

Interest rates are lower on 15-year loans compared with 30-year loans. In that same example, if you instead refinanced into a 15-year mortgage with a 3% interest rate, you’d save a whopping $94,000 in interest compared to sticking with the original loan. Plus, you would be free from mortgage payments seven years earlier. 

The tradeoff is that you’ll pay roughly $250 a month more compared to keeping the original loan. 

Years left to payInterest rateMonthly paymentTotal remaining principal and interest dueClosing costs (approx.)
Original Mortgage 224.5%$1,662$439,000n/a
New Refinance Mortgage (30-year)303.5%$1,248$449,000$15,000
New Refinance Mortgage (15-year)153%$1,919$345,000$15,000

When a Refinance Probably Doesn’t Make Sense

Refinancing isn’t free. 

Adding more years to your mortgage can equal thousands of dollars in additional interest, and closing costs will eat into your savings too. Even in a “no-cost” refinance, the act of taking out a new mortgage will cost you anywhere from 3% to 6% of the total mortgage. 

So the value in refinancing changes if you don’t plan on keeping the home long term. You need to be sure you’ll be staying in the home long enough for the savings to outweigh the refinance closing costs. If you plan to move in the next 2-3 years, refinancing isn’t the best option.

Another thing: The refinance interest rate you can qualify for is highly dependent on your credit score and overall financial health. If you have a low credit score, it will be more difficult to qualify for a mortgage refinance. You also won’t be eligible for the lowest, headline-grabbing interest rates. In this situation, you’d be better off improving your credit and looking at refinancing in the future.

Refinancing your mortgage is a decision that has ripple effects on other areas of your financial life. So you need to balance this choice with your other financial priorities. If the pandemic has reduced your income or made your income less secure, the cash you’d spend on closing costs could be better used to establish an emergency fund instead. 

Low interest rates are a great reason to refinance. But they shouldn’t be the only reason. Doing the math to know when you’ll break even on new interest and closing costs will help you determine if it makes sense for you.