According to data published in January 2016, 5.2 million borrowers could have both gotten and benefited from a mortgage refinance in November 2015. Of those, some 2.4 million could have cut at least $200 from their monthly payments. However, the report's authors at Black Knight Financial Services reckon that even a modest 50-basis-point increase (a basis point is 1/100th of 1 percent, so that's like a 4.0 percent rate rising to 4.5 percent) in current mortgage rates would reduce the number who are eligible for refinancing and would find it beneficial by 2.1 million homeowners.
In other words, if you're thinking of refinancing, and you believe (as most currently do) that those rates are likely to rise, you'd better get a move on. But, before you do anything, you might want to ask yourself how your refinance will affect your net worth.
What is Net Worth?
"Net worth" is one of those financial terms that sounds complicated, but is actually very simple. You add up the current market value of all your assets (your home, car, savings, investments, retirement funds and personal property such as jewelry, artwork, collectibles and so on) and deduct all your liabilities, which are commonly the balances owed on your mortgage, student loan, auto loan, personal loan, home equity loan, credit cards and all other debts. Now you know what you're worth, though only financially.
So net worth is clearly an important indicator of personal financial success (or the opposite), and some people obsess about theirs. But most see money as only one component in the life they want, and prioritize other things – such as the health and happiness of themselves and those they love – alongside it. When you're deciding about the implications of refinancing for your net worth, you may want to bear that in mind.
How a Mortgage Refinance Commonly Harms Net Worth
There are two ways in which refinancing often hurts net worth.
The first is a cash-out refinance. You can learn more about these at the Pros and Cons of Cash-out Refinancing, but it's when you take out some of the equity in your home (the difference between the current market value of the property and the balance left on the mortgage) in cash by switching to a bigger mortgage. Unless you use all the cash to purchase other assets, basic math will see your net worth fall because your liabilities will increase. The same will happen, though maybe over a longer period, if you buy assets that depreciate, such as cars, recreational vehicles or boats. In 10 years' time, those might be close to worthless, but chances are you'll still be paying for them in monthly mortgage payments for decades to come. This is where your personal priorities and values come in: Are you willing to have your net worth take a hit in order to buy something that makes you or those you love happier – a wedding, maybe, or help with college costs or a mortgage down payment? Having said that, repeatedly refinancing in order to sustain an unsustainable lifestyle rarely ends well.
The second potentially damaging sort of refinancing is when you're doing so in order to get a better rate, but your new mortgage has the same term that your original one had. So, for example, you have a balance today, 10 years into your 30-year loan, of $200,000. You refinance that $200,000 in a new 30-year mortgage. Oops!. You've reset the clock. You're going to be paying down that $200,000 over 30 years instead of 20 years, and everyone knows the longer you owe money for, the more total interest you pay over the lifetime of the loan. So that refinance may have reduced your monthly payment, but – unless the new rate is way lower – it's almost certainly going to cost you in the end . Plus, you're going to have that millstone around your neck for an extra decade. The alternative that should protect your net worth is to choose a shorter mortgage, maybe one that lasts 15 or 20 years. Use mortgage calculators to reckon how different models would work for you, and compare the amortization schedules for your existing and new loans.
Refinancing to Protect Your Net Worth
Depending on your priorities, refinancing to a shorter-term loan is usually smart. However, for some it can be more complicated than that. If you think your circumstances mean you might be an exception to the shorter-is-better rule, check out The Benefits of Having a Long Mortgage.
One group who may well find that refinancing will protect their net worth in the long run are those with adjustable-rate mortgages (ARMs). Nowadays, nearly all these are "hybrids," meaning they come with a fixed rate for an agreed initial period (often three, five or seven years), and then float when that expires. If the many experts who are predicting interest rate rises turn out to be correct, homeowners with ARMs could be facing painfully sharp increases in their monthly payments – and those could eventually cause significant harm to their net worths. People in that position might find themselves better off refinancing soon, regardless of the term length of the mortgage they can afford.
Another way to minimize the harm a refinancing can do to your net worth concerns closing costs. If, as is commonly an option, you choose to roll those up into the loan, you're borrowing yet more money, and then paying interest on it for up to 30 years. And that's an additional liability. If you can afford to, you might prefer to pay your closing costs from your savings.
There's more to life than net worth, and sometimes you may legitimately choose to sacrifice some of yours for something you value more. But problems can arise if you ignore it completely. Only you can decide on the importance you attach to the things in your life.