Home Refinance Pros and Cons: What You Need to Know
Are you wondering if refinancing your mortgage makes sense for your financial situation? This home refinance guide will help you understand the advantages and disadvantages of refinancing your home. You’ll learn how to refinance a mortgage to a lower interest rate and lower monthly payment, as well as discover the costs of refinancing and other potential drawbacks. Keep reading to learn more about the pros and cons of refinancing and how they might impact your decision.
Key Takeaways
Refinancing a home means replacing your current mortgage with a new loan.
Refinancing can provide opportunities to lower your monthly payment, reduce your interest rate, or access your home equity.
Refinancing a home is not without costs and may not always be the best solution for your financial situation.
What is Refinancing?
Refinancing a home means replacing your existing mortgage with a new loan. You can refinance your primary residence or an investment property. The goal of refinancing is to give your home loan more favorable terms. By adjusting your loan terms, you can achieve specific financial goals, such as lowering your monthly payments or changing the repayment period. You can refinance a mortgage to:
Refinancing a mortgage can help you: Lower your monthly payment Save on interest over the life of the loan Tap into your home equity If you have an adjustable-rate mortgage, you can refinance to a fixed-rate mortgage for predictable monthly payments.
Refinancing a mortgage isn’t always the best solution for everyone. It’s important to consider your goals and whether refinancing will help you achieve them.
Understanding Home Refinancing
Refinancing a mortgage means replacing your existing home loan with a new one. You can refinance your primary residence or an investment property. The goal of refinancing is to give your home loan more favorable terms. You can refinance a mortgage to a lower interest rate, to change the loan term or to tap into your home equity.
There are two main types of refinancing: cash-out refinance and rate-and-term refinance. A cash-out refinance lets you take out more money from your home by tapping into your equity. You can use the funds for home improvements, paying off high-interest debt or funding a big purchase. A rate-and-term refinance focuses on changing the terms of your mortgage to more favorable ones. You can refinance to a lower interest rate or to a shorter loan term.
Benefits of Refinancing Your Mortgage
Refinancing a mortgage can help you in several ways. You can lower your monthly payment, tap into your home equity or pay off your mortgage sooner. The benefits of refinancing include:
Lower Interest Rate
A lower interest rate is one of the greatest benefits of refinancing a mortgage. Lowering your interest rate can save you thousands of dollars on interest payments over the life of the loan. You can apply the savings to your monthly payment or to paying off your mortgage sooner.
If you have a high interest rate, refinancing to a lower rate can help you save money on interest. A 0.5% to 0.75% drop in interest rate can make a big difference in your monthly payment and overall savings.
Reduced Monthly Payments
A lower monthly payment is one of the most obvious benefits of refinancing a mortgage. You can lower your monthly payment by refinancing to a lower interest rate or by extending the loan term.
Access to Home Equity
A lower monthly mortgage payment can give you more room in your budget to save, invest or pay off other high-interest debt. You can use the money to travel, pay off debt or invest in your children’s education.
Shorter Loan Term
Opting for a shorter loan term through refinancing can enable you to pay off your mortgage more quickly and build home equity faster. You can refinance from a 30-year mortgage to a 15-year loan and save thousands of dollars in interest over the life of the loan. If you can afford the higher monthly payment, refinancing to a shorter term can be a great way to be mortgage-free sooner.
Paying off your mortgage sooner can give you peace of mind and free up a significant amount of money in your budget. You can use the money to invest, pay off debt or save for a big purchase.
Accessing Home Equity
A cash-out refinance lets you tap into your home equity to fund home improvements, pay off high-interest debt or cover a big expense. You can refinance your mortgage and take out more money than you currently owe with a cash-out refinance. The amount you can borrow is based on your home’s value and your mortgage balance.
You can usually borrow 70% to 85% of your home’s value, depending on your creditworthiness. It’s important to have at least 20% equity in your home to avoid paying private mortgage insurance (PMI).
You’ll need to provide financial documents to apply for a cash-out refinance, and an appraisal may be required. Refinancing a mortgage with a cash-out can be a complex process, but it can be worth it to access your home equity.
Switching to a Fixed-Rate Loan
Are you worried about rising interest rates with your adjustable-rate mortgage? You can refinance to a fixed-rate mortgage for predictable monthly payments.
A fixed-rate gives you peace of mind and protects you from increasing interest rates. If you have an adjustable-rate mortgage, you’re at the mercy of economic conditions. An ARM is tied to a financial index, so when the index rate rises, so does your mortgage rate. Refinancing to a fixed-rate mortgage can give you predictable monthly payments and save you from financial stress.
Drawbacks of Refinancing Your Mortgage
The benefits of refinancing a mortgage are significant, but it’s important to consider the drawbacks before refinancing. You can avoid potential problems by understanding the negatives of refinancing.
Closing Costs
One of the biggest drawbacks of refinancing a mortgage is paying closing costs. You’ll need to pay fees to finalize your new loan, which can add up quickly. Refinancing a $200,000 loan can cost 2% to 6% of the loan amount in fees, which is $4,000 to $12,000. These fees are often referred to as closing costs refinancing and include various charges such as appraisal, origination, and attorney fees.
You’ll pay a range of fees, including origination fees, appraisal fees, and more. Closing costs can add up quickly, and refinancing a mortgage may not be worth it if you have to pay several thousand dollars in fees.
You can avoid paying closing costs by refinancing with a lender that offers no-closing-cost mortgages. You can also ask your lender to roll the costs into your loan, so you pay the fees back over the life of the loan. Another option is to accept a higher interest rate in exchange for someone else paying your closing costs. This can be a good option if you want to avoid paying closing costs out of pocket. However, you’ll end up paying more in interest over the life of the loan.
Higher Monthly Payments
Refinancing to a shorter loan term can result in higher monthly mortgage payments. By switching from a 30-year mortgage to a 15-year loan, you can save a substantial amount on interest and build home equity more quickly.
Make sure you can afford the higher monthly payments. You’ll need to have room in your budget to handle increased mortgage payments, as well as other expenses, in case of an emergency or if you lose your job.
Lengthening Your Loan Term
Refinancing to a longer loan term can give you a lower monthly payment, but it’s not the best way to reduce your mortgage payment. You’ll pay more in interest over the life of the loan, and it will take longer to build equity in your home.
For example, refinancing a 20-year mortgage to a 30-year mortgage can lower your monthly payment, but you’ll pay thousands more in interest over the life of the loan.
Impact on Credit Score
Applying for a new loan to refinance your mortgage means a lender will pull your credit report and score. This hard inquiry can lower your credit score.
The damage is minor and temporary. Your credit score should recover once you make on-time payments on your new mortgage. Avoid applying for multiple loans or credit at the same time, as this can further harm your credit score.
Increasing Debt
Refinancing a mortgage loan can lead to taking on too much debt. You might be tempted to borrow more than you need and finance home improvements or pay off debt at the expense of your long-term financial goals.
For example, you can refinance your mortgage loan into a longer loan term to lower your monthly payment. This can be tempting if you’re not sure how to manage your expenses, but you’ll pay more in interest over the life of the loan. You’ll also take longer to build equity in your home.
Breaking Even on Closing Costs
Breaking even on closing costs means you refinance long enough to equal the costs of refinancing. You can calculate your break-even point by dividing the closing costs by the difference between your monthly payments.
When evaluating the financial viability of refinancing, it's essential to factor in homeowners insurance as one of the expenses associated with closing costs.
If you plan to keep your home and don’t plan to move for several years, refinancing might be a good option. You can also break even on closing costs by lowering your monthly payment and applying the savings to your loan balance.
Break-Even Calculation Example based on an actual 7.5% current loan:
Here’s a breakdown of how to calculate your break-even point:
Loan: $200,000
New interest rate: 6.5%
Closing costs: $4,000 (2% of the new loan)
Monthly savings: $134
| Loan Amount | Original Interest Rate | New Interest Rate | Closing Costs | Monthly Payment (Original Rate) | Monthly Payment (New Rate) | Monthly Savings | Break-Even (Months) | Break-Even (Years) |
|---|---|---|---|---|---|---|---|---|
| $200,000 | 7.5% | 6.5% | $4,000 | $1,398 | $1,264 | $134 | 30 | 2.5 |
Disclaimer: This is informational only and should not be relied upon by you. Rates are subject to change. Loan examples are just examples, your situation may vary. Contact Reasy Financial to learn more about your eligibility for mortgage products.
NMLS# 2446155 | AZ 1044208 Financing is shown for comparison only. This is not an offer of credit or commitment to lend. Loans are subject to buyer and property qualification. Rates and fees are subject to change without notice. Cash reserves may be required for some conventional loans.
You’ll need 30 months (approximately 2.5 years) to break even on closing costs. If you plan to keep your home for at least 2.5 years, refinancing could be a good option. You can also consider applying your savings to the loan balance to break even sooner.
Other factors to consider when evaluating refinancing include:
Interest rates: Could interest rates rise or fall in the future?
Property values: How has your local market impacted your home’s value?
Your financial situation: Is your income stable, or do you expect it to change in the future?
Refinancing to Remove Private Mortgage Insurance (PMI)
Refinancing your home loan can be a strategic move to eliminate Private Mortgage Insurance (PMI) from your monthly mortgage payments. PMI is typically required when you put down less than 20% of the home’s value as a down payment. However, if you’ve built up enough equity in your home, you may be able to refinance and remove this extra cost.
Is Refinancing Right for You?
Refinancing your mortgage isn’t right for everyone. You’ll need to consider your financial goals and weigh the benefits of refinancing against your needs. It’s important to compare rates and lenders to ensure you’re getting the best deal. You should also consider your personal situation and how refinancing will impact your life.
Evaluating Your Financial Goals
Before you refinance, make sure you understand your current mortgage. What’s your interest rate and loan balance? What are your goals? Do you want to build equity in your home faster? Do you want to save money on your monthly payment? Are you working toward a bigger financial goal, like retiring debt or funding your kids’ education?
Refinancing can help you achieve your goals, but you need to consider how refinancing will impact your finances. For example, if you want to pay off your mortgage faster, refinancing to a shorter loan term could be a good option. If your goal is to lower your monthly payment, you might find that refinancing to a longer loan term or securing a lower interest rate is more suitable for your needs.
Comparing Rates and Lenders
You should always shop around and get quotes from multiple lenders when refinancing your mortgage. You can choose a loan term and type that fits your budget and compare interest rates from different lenders. You might be surprised at the savings you can find. Even a quarter of a percent difference in interest rate can save you thousands of dollars in interest over the life of the loan.
When evaluating your financial situation, consider your credit score and debt. A good credit score can help you qualify for better refinancing rates, so you may want to work on improving your credit before applying for a loan.
Considering Your Timeframe
How long do you plan to stay in your home? Refinancing can be a great option if you plan to keep your home for a long time. You can save thousands of dollars in interest and enjoy other benefits, like building equity faster. However, if you plan to sell or move in the next few years, refinancing might not be the best option. You’ll have to pay closing costs and it will take you several years to break even on the costs.
Your timeframe should factor into your decision to refinance. You’ll need to consider how many years you’ll remain in your home and if refinancing will help you achieve your long-term financial goals.
Alternatives to Refinancing
Refinancing might not be the best option for you. You have other ways to access your home’s equity and funds for home improvements or other expenses. Consider a home equity loan or line of credit, or a personal loan.
Home Equity Loan
A home equity loan lets you borrow a lump sum of money, usually based on the amount of equity you have in your home. You’ll have a fixed interest rate and a set amount of time to repay the loan, such as 10 or 15 years. A home equity loan is a good option if you need a one-time lump sum of cash. You can use the money to finance home improvements, pay off debt, cover a big expense or more.
Keep in mind you’ll need to pay closing costs and fees to get a home equity loan. You’ll also need to have at least 20% equity in your home to qualify. A home equity loan can provide stability with a fixed interest rate and a lump sum of cash. You’ll have a set amount of time to repay the loan, such as 10 or 15 years.
Home Equity Line of Credit (HELOC)
A Home Equity Line of Credit (HELOC) is a revolving line of credit that allows you to borrow the equity in your home, much like a credit card. You're only charged interest on the amount you borrow, and you can borrow as much or little as you need, whenever you need it. A HELOC is a great option if you need access to extra money for ongoing expenses, such as home improvements, college tuition or retirement, or if you want to consolidate higher-interest debt. You can use the money to pay off debt, such as credit cards, and enjoy having a lower interest rate and tax-deductible interest. You'll have a set draw period, usually 10 years, and once that time is up, you can choose to repay the loan in full or modify it to a fixed-rate home equity loan.
Personal Loans
A personal loan allows you to borrow a single lump sum of cash and repay it in fixed monthly payments over time. You'll have a fixed interest rate, so you'll know exactly how much you owe each month. Personal loans are a great option if you need to pay off debt or cover a one-time expense, such as a wedding, home improvement or major purchase. Unlike a HELOC, a personal loan is unsecured, so you won't risk your home if you're unable to repay the loan. Plus, personal loan interest rates are often more competitive than credit card rates, and you can get your money quickly, usually within days of approval.
Mortgage Refinance Checklist
Refinancing your mortgage can be a great way to lower your monthly payment, save on your loan or switch from an adjustable-rate mortgage to a fixed-rate loan. Before you refinance, consider the following:
If refinancing isn't in the cards for you right now, you have other options to tap your home's equity or borrow money. You can consider a home equity line of credit (HELOC) or home equity loan, or a personal loan. Each has its advantages and disadvantages, so be sure to weigh the pros and cons before committing to anything.
The Bottom Line
Mortgage refinancing can be a great way to save money, lower your monthly payment or tap your home's equity. But refinancing isn't right for everyone, and you'll want to consider the drawbacks of refinancing, including higher debt and closing costs.
Be sure to carefully consider the terms of a new loan and your financial goals before refinancing. You may also want to consider other options, such as a home equity line of credit or personal loan. With any big financial decision, it's important to take your time and consider your options carefully.
Frequently Asked Questions
What are closing costs for refinancing a mortgage?
Refinance mortgage closing costs typically range from 2% to 6% of your loan amount, and include origination fees, appraisal fees and other charges.
You should always budget for closing costs!
How does a cash-out refinance work?
A cash-out refinance lets you take out more than you owe on your home and pocket the difference in cash. You'll need at least 20% equity in your home to qualify.
It's a great way to consolidate debt or fund home improvements.
What is the impact of refinancing on my credit score?
Refinancing can lower your credit score by about 10 to 20 points, due to the hard inquiry lenders make when processing your application. However, the damage is minor and temporary, and your score will recover over time.
As long as you monitor it, it shouldn't cause stress!
What is the difference between a home equity loan and a HELOC?
A home equity loan gives you a lump sum and a fixed interest rate, with set payments. A HELOC lets you borrow as needed, with variable interest rates.
It's up to you if you prefer a set payment or extra flexibility!
How do I determine if refinancing is right for me?
Refinancing might be a good option for you if it will help you achieve your financial goals, such as saving money on your loan or lowering your monthly payment.
Take a close look at your current situation and compare options before making a decision.