Refinancing

The Pros & Cons of Refinancing Your Home

Dec 24, 2018, 9:15 AM | Robin Johnson
A beautiful home where the owners are trying to decide if they should refinance

Refinancing offers some serious benefits. It can allow you to pull cash out of your home, lower your interest rate and monthly payments, get a shorter mortgage term, or access other benefits.

On the other hand, refinancing can be a long process and, depending on your situation, might not be the best choice for you financially. Refinancing comes with fees, and these could potentially outweigh the potential savings or deepen your debt burden.

So how do you know whether refinancing is right for you? Keep reading to learn about some of the things you'll want to consider when thinking about refinancing your home loan.

6 Potential Pros of Getting a Mortgage Refinance

1. Lower Interest Rate

A lower interest rate can reduce your monthly mortgage payments significantly. In an example from MoneyCrashers, if you previously had a 6% interest rate on a $250,000 mortgage, you could save $300 per month by refinancing to a 4% interest rate.

For some, a savings of $300 per month could keep them in their home, help pay other bills, or save them from a loan default that would damage their credit score.

2. Cash Out on Equity

An exciting refinance option is the cash-out refinance, which allows you to pull cash from your equity and possibly take advantage of lower rates. With a cash-out refinance, you get a new mortgage that is larger than the amount you owe on your old mortgage, leaving you with leftover cash.

You can can use this money for anything you want: to pay off high-interest debt, buy a car or make another large purchase, fix or expand your home to make it more valuable, go on a vacation, or anything else.

3. Consolidate Higher-Interest Debt

Paying off consumer debt with a home refinance can be a great option. Transferring your higher-interest debts into lower-interest mortgage debt can save you a lot of money.

While credit cards may have interest rates of 10% to 20% or more, mortgage rates are usually between 3% to 6%. Plus, you can get away from unpredictable monthly payments on your other debts, and enjoy a set mortgage rate and payment instead.

And, as NerdWallet points out, mortgage interest can be written off on your taxes, which is something you can't do with credit card or other consumer debt.

4. Shorter Loan Term

Changing your loan term, or the amount of time it takes to pay off your loan, can save you money. These savings are usually the most drastic over the long-term, but sometimes you can also experience significant savings immediately.

However, it's important to note that these short-term savings are not normally typical. Most of the time, refinancing into a shorter term actually increases your monthly payments. But this doesn't mean it isn't worth it. It just depends on your financial goals and current situation.

5. Replace an Adjustable Interest Rate with a Fixed Rate

Switching from an adjustable-rate mortgage (ARM) to a fixed-rate mortgage can potentially save you a lot, depending on how long as you plan on staying in your home and what rates are doing.

One of the gamles with an ARM loan is that you usually start with a low rate, but you could see that rate climb after the fixed period ends (which usually occurs after 3–10 years).

If you want to avoid this situation, you have a couple of options. First, you can sell your home before this transition to avoid a potential rate hike.

Or, if you plan to stay in your home longer, refinancing to a fixed rate can lower your interest rate and help you steer clear of the uncertainty associated with changing rates.

6. Rid Yourself of Mortgage Insurance

Private mortgage insurance (PMI) can cost you thousands of dollars every year.

On conventional loans, PMI can be canceled, upon request, once the balance of your mortgage reaches or drops below 80% loan-to-value ratio (LTV). It will also be automatically be dropped by your lender once you hit 78% LTV.

If a refinance can get you to a 78% LTV or lower, it may save you enough on PMI to cover closing costs and other fees (which we'll discuss below) within a few years and allow you to start saving.

FHA loans often require insurance payments for the entire life of the loan, regardless of your LTV. So, if you want to get rid of these payments, you have to refinance into a different loan type.

4 Potential Cons to Getting a Mortgage Refinance

1. New Application Process

Even though you've qualified for a mortgage before, that doesn't guarantee that you'll be approved for a refinance loan.

Current information, including your credit score, recent pay stubs, tax returns, and more, may all be taken into account by the lender. And if your financial situation or creditworthiness has changed, you might not get the favorable terms you desire—or even get approved.

However, if you qualify for a streamline loan, you may be able to avoid this con.

2. Cost & Effect of an Appraisal

The amount that's available to you in a conventional refinance is determined by how much your home appraises for.

A lower-than-expected appraisal value can mean the lender will only be able to approve an amount that is less than your current mortgage. If this happens to you, you'll want to wait until either you've paid more on your mortgage or your property values rise.

It's important to note that not all refinances require an appraisal. So if you're concerned about this potential negative to refinancing, you can always to lenders about refinances loan types that don't require an appraisal to see if you qualify.

3. Financial Impact of Fees & Closing Costs

A refinance loan, similar to a new loan, charges closing costs that equal about 2% to 5% of the entire mortgage amount. You'll might also have to pay for additional necessary parts of the process, like an appraisal, a credit report, and discount points.

You might also be charged extra fees that add to the cost of the refinance. Some or all of these costs can be added to the loan balance, but that means you'll be paying for them over time, with interest.

4. Danger of Increased Debt

In one article, Money Crashers reminds us that additional debt may hurt borrowers who currently have to go deeper into credit card debt each month to pay their bills.

If you get a refinance to pay off some of this debt, but you still keep racking up the credit card bills, the refinance might not be enough to help. And though defaulting on a credit card is bad, it's worse to default on a mortgage and go into foreclosure.

To avoid this kind of mistake where you dig yourself deeper into debt, you should only get a refinance if you have a very deliberate plan to use and cash-out money to improve your financial health. It might be necessary to attack the root cause of your monthly deficit before refinancing.

The Bottom Line

Depending on your circumstances, refinancing could be a great choice for you. You could lock in a low interest rate, lower your monthly payments, and save thousands over the long term.

If you're not sure if it's the right choice, don't hesitate to call one of our mortgage experts at (888) 935-3828. There is no obligation to get a refinance, and we can help you analyze your financial situation and goals to see if refinancing is or isn't the right choice.

Robin Johnson