The Pros And Cons Of Refinancing Your Home Loan
If you’re a homeowner, you may refinance your mortgage to take advantage of low interest rates, change your loan term or convert your home equity into cash. A mortgage refinance can help save you money or lower your payment.
However, refinancing also comes with some drawbacks, depending on market conditions and your personal situation and financial goals. It’s important to fully understand the process before committing to a mortgage refinance.
Let’s explore the pros and cons of refinancing a mortgage to see if this option is right for you.
What Is Refinancing?
The refinancing process involves replacing your home loan with a new mortgage that has more favorable loan terms, like a lower interest rate or shorter loan repayment period. The new loan may also allow you to tap into your home’s equity, which you can use to fund home improvements or pay down debt.
Depending on your personal and financial needs, and whether you meet certain requirements, you may have multiple refinance options. Some of the most common types of mortgage refinances include (but aren’t limited to) the following:
- Cash-out refinance: A cash-out refinance allows you to convert your home equity into cash. In doing so you replace your mortgage with a larger home loan. You’re essentially borrowing more money than you owe on your home and taking the difference in cash.
- Rate-and-term refinance: A rate-and-term refinance lets you trade in your mortgage for a new loan with more favorable loan terms, like a lower interest rate. A rate-and-term refinance may be a good option if you’re looking to secure better loan terms than you had with your original mortgage.
- Cash-in refinance: With a cash-in refinance, you’re putting a lump sum of money into your mortgage. This can be an effective option if you have the means to do so. It can help you lower your monthly mortgage payments, shorten your repayment period, build up your home equity or cancel PMI.
Keep in mind that each type of mortgage refinance has criteria you must meet to qualify. For example, with a cash-out refinance, you’ll need a credit score of 620 or higher in most cases, and you’ll need to leave at least 20% equity in your home once you’ve refinanced with the larger loan (unless it’s a VA loan).
Other qualifying factors typically include your debt-to-income ratio (DTI), loan-to-value ratio (LTV), lender income requirements and, possibly, additional documentation that goes beyond the standard paperwork necessary to be approved for a mortgage. Be sure you know what you need to qualify before applying for a loan refinance.
Pros Of Refinancing Your Mortgage
Refinancing can be an incredibly practical way for you to achieve your personal and financial goals. However, the terms of your new loan and your reasons for refinancing can affect how beneficial refinancing is for you.
Up next are some of the benefits of refinancing so you can be more prepared to determine if this option is right for you.
Locking In A Lower Interest Rate
Securing a low mortgage interest rate is one of the most common reasons to refinance, especially if rates are lower now than when you first took out your mortgage. Lowering your interest rate can help you save money on interest payments over the life of the loan.
Factors to consider before taking advantage of a low mortgage interest rate include;
- How long you’ve had your existing mortgage
- The difference between your current and would-be-new mortgage rate
- How much you might spend closing on your new loan
Before choosing to refinance to a lower rate, talk with your lender about how much money you’ll actually save over time.
Paying Off Your Mortgage Sooner
Refinancing is a great option if you’re looking to shorten your loan term and pay off your mortgage sooner. For example, if you have a 30-year mortgage and 25 years left to pay it off, refinancing to a 15-year mortgage means you would pay it off 10 years earlier than anticipated.
The trade-off is that your monthly mortgage payments will be higher. But, you’ll be paying more toward the principal balance and less in interest over the life of the loan. Plus, you’ll be building equity in your home at a faster rate.
Lowering Your Monthly Mortgage Payments
On the flipside, you may want to lower your monthly payments. Refinancing allows you to lengthen your loan term if you’re having trouble making your payments. The downsides are that you’ll be paying off your mortgage longer and you’ll pay more in interest over time. However, a longer loan term can make your monthly payments more affordable and free up extra cash.
Converting Your Home Equity Into Cash
As noted earlier, a cash-out refinance lets a borrower tap into their home equity and convert it into cash. If you meet the requirements for a cash-out refinance, you’ll borrow more than you owe on your mortgage and keep the difference in cash. Keep in mind, for most cash-out refinances, you need to leave at least 20% equity in your home.
For example, let’s say you have $200,000 left on your mortgage and your house is valued at $300,000. That means you have $100,000 in home equity. Let’s suppose you’d like to use $50,000 of it for a few different things.
You can use a cash-out refinance to borrow this $50,000 against the equity in your home. So, your new mortgage balance would be $250,000 ($200,000 + $50,000).
You can then use this money to achieve various financial goals, like funding home improvements or renovations, consolidating debt or boosting a savings, college or retirement fund.
Switching To A Fixed-Rate Mortgage
If you have an adjustable-rate mortgage (ARM), which can come with fluctuating interest rates and unpredictable monthly mortgage payments, a refinance can help you switch to a more reliable fixed-rate mortgage. If mortgage rates are now low, changing to a fixed-rate mortgage can help you lock in a favorable mortgage rate and save you money on interest.
Cons Of Refinancing Your Mortgage
Depending on your situation, refinancing might not be in your best interest. Let’s go through some of the disadvantages of refinancing a home loan.
Paying For Closing Costs
Refinancing is similar to taking out a mortgage for the first time in that you’re still expected to pay closing costs. These fees can be anywhere from 3% – 6% of your new loan amount. For a $200,000 mortgage, for instance, you can expect to pay $6,000 – $12,000 in closing costs.
Fees covered in closing costs include the application fee, loan origination fee, home appraisal fees, homeowners insurance and lender fees. Evaluate whether the costs associated with closing on your new loan are worth the savings that come with a refinance.
Increasing Your Monthly Payments
Another downside of refinancing is that you could end up increasing your monthly mortgage payments. If you refinance to a mortgage with a shorter repayment period, this could increase your monthly payments because you have less time to pay off your loan.
The advantage of this option is that you’ll pay off your mortgage quicker. But, if you can’t afford higher monthly mortgage payments, this won’t be the best refinance option for you.
Lengthening Your Loan Term
The tradeoff of lowering your monthly mortgage payments is that it will increase the time necessary to pay off your new loan. Lengthening your loan term also means you’ll be paying more in interest over the life of the loan. Consider shortening your term – which increases your monthly payments – if you want to reduce how long it takes to pay off your mortgage.
Should You Refinance Your Home Loan?
Whether it’s a good idea to refinance your mortgage largely depends on your situation and your goals. You might also choose to refinance simply because mortgage rates are low and you’re likely to save money over the life of your loan. No matter the circumstances, you’ll be in a better position to refinance if you have a good credit score and meet other lender requirements.
Refinancing isn’t for everyone. For instance, you might not want to refinance if rates are high or you plan to move soon. Or it might not be a good time to refinance if you are experiencing financial hardship or having trouble affording your monthly mortgage payments. Maybe you recently bought your house, and it’s just too soon to refinance your mortgage.
Before deciding on whether to refinance, speak with your lender or one of our Home Loan Experts.
The Bottom Line
Refinancing your mortgage may be a good option if you’re looking to change your term, take advantage of low interest rates or access the equity you’ve built in your home. You’ll have to cover the costs of refinancing, though, and you might not want to take on the new rate, term or monthly payment.
Weigh the pros and cons of refinancing before deciding whether it’s right for you. If you’re considering a mortgage refinance, fill out an application today.