The Real Pros and Cons of Refinancing Your Mortgage
Whether you’re watching television or following an Internet livestream, it’s impossible to avoid the countless mortgage refinancing ads that have cropped up over the last several years. Despite the marketing push, however, refinancing a mortgage isn’t a one-size-fits-all solution for every homeowner. Financially speaking, deciding whether or not to refinance your home is rather like choosing a health insurance policy, because it greatly depends upon your individual situation, finances and lifestyle.
Why refinance your mortgage?
Homeowners typically refinance their mortgage to take advantage of lower interest rates, especially if they purchased their home when rates were significantly higher. Likewise, many first-time homeowners find it necessary to pay a minimum down payment (with longer mortgage terms) due to straitened finances.
When you refinance your mortgage, you’re basically entering into an entirely new agreement that allows you to change the length, payment and interest terms of your original loan. For some homeowners, refinancing can save tens of thousands of dollars; but for others, refinancing might actually cost more time and money than it’s worth.
Here’s a look at the pros and cons of refinancing your mortgage, along with some tips to help you decide whether or not it’s right for you.
Refinancing Pros
- Lower interest rates
This is the primary reason why many homeowners choose to refinance their mortgage. If you purchased your home when interest rates were higher, refinancing will allow you to take advantage of the current low rates.
According to the experts, if you can save as little as one percent on your monthly interest rate, then you should probably decide to refinance. Just consider: On a mortgage of $125,000 with nine percent interest, your monthly payments will be $937 a month. At six percent, your monthly payments will decrease to $625 — a savings of $312 a month.
• Lower mortgage payments
Refinancing your mortgage will enable you to lower your monthly payments by a) lowering your interest rate or b) lengthening the life of your loan. Also, you can decrease your monthly payments by eliminating your FHA loan, which charges higher insurance rates (more about this later).
• Shorter mortgage length
Refinancing your mortgage allows you to shorten the term of your loan so you can pay off your mortgage more quickly. While this involves higher monthly payments, you’ll end up paying a lot less interest.
• Allows you to switch from adjustable to fixed-rate payments
At the time you bought your home, you probably had a good reason to choose your payment terms; but as interest rates change and your own economic status evolves, you might find it advantageous to switch your payment terms from adjustable to fixed-rate (or vice-versa). If interest rates have dropped sufficiently, switching to a fixed-rate mortgage can give you a huge financial advantage; and you can lock in that rate for the entire life of the loan.
• Enables you to discontinue FHA loan
FHA loans can provide a great opportunity for potential homeowners who can’t afford a large down payment or have a lower credit score. However, if you purchased your home with an FHA loan and chose to pay only the minimum down payment, you’re stuck with paying an FHA mortgage insurance premium (MIP) for the entire term of the loan.
If your down payment was lower than 20 percent of the loan, this can be especially expensive because an FHA MIP is nearly double the price of private mortgage insurance from a conventional insurer. By refinancing your mortgage, however, you can transfer your FHA loan to another lender and eliminate these higher MIP payments.
• Allows you to tap into your equity
If you need cash for home improvements or to pay off debts, a cash-out refinance allows you to take out a loan for up to 90 percent of your home’s equity.
Refinancing Cons
• Your loan might be denied
If home values are down or the market is soft, you might get a lower appraisal for your home, which could result in your loan application being denied. Likewise, factors such as job loss, a low credit score or a higher debt-to-income ratio could all negatively impact your loan decision. If your career or finances have taken a major downturn, it’s probably a good idea to wait and refinance later when your prospects are better.
• Possible higher monthly payments
If you choose to shorten the length of the loan, your monthly payments will be higher, although you’ll save in interest fees. Likewise, refinancing to shorten the length of your loan might sound like a good idea in theory; but in practice, it involves higher monthly payments that might put a strain on your budget. An online mortgage calculator can help you figure out exactly how much you’ll save each month.
• Reduced home equity (for cash-out refinancing)
If you opt for cash-out refinancing, you’ll reduce your home’s equity. Plus, resetting the length of your loan could result in more months of paying interest.
• Fixed-rate limitations
A fixed-rate means just that; your interest rates won’t change. This means that if interest rates drop during the life of your loan, you won’t be able to take advantage of these lower rates unless you refinance your mortgage all over again. That’s why it’s better to wait on refinancing until it looks like interest rates have hit rock bottom.
• Refinancing restarts your mortgage
Refinancing means that you’re restarting your loan, and this might not be a good idea in some circumstances. For example, if you’ve already lived in your home for more than five years and you want to refinance it for 30 more years, it might end up costing you more because of factors such as closing fees and financing costs, as well as added years of interest payments. In addition, if you’re planning to relocate anytime soon, then refinancing probably won’t make financial sense in your situation.
• Closing costs
This may come as a surprise, but closing costs aren’t standard — rather, they vary from state to state, and can also vary according to lender.
Typically, closing costs range from two to three percent of the value of your mortgage loan. Most experts agree that you need to live in your home for at least a year to recoup your initial refinancing costs and actually see a financial advantage.
Refinancing your home sounds like a great idea when you hear about it on TV, but as with most sales pitches, it takes a bit of research to uncover the truth. If you’re considering whether or not to refinance, the best thing you can do is find an online mortgage calculator and find out how much your new payments will be, then factor in refinancing fees and closing costs. By comparing these numbers, and taking into account how much you’ve already paid on your mortgage, you should get a good idea of whether or not refinancing will be beneficial to you in the long run.
