Refinancing a home could help you achieve short- and long-term goals. But in many cases, refinancing isn’t the only or best choice.
When deciding if the disadvantages of refinancing a home loan outweigh the advantages, take a comprehensive look at your financial situation. For example, simply paying off the loan as fast as possible may not be the most important aim for you. “We’re not driven just to take people to zero,” says Dave Demming, Sr., a certified financial planner and the founder and president of Demming Financial Services Corporation.
[Read: Best Mortgage Lenders]
Pros of Refinancing a Mortgage
Refinancing can be a good idea when doing so will save you money over the life of your mortgage. Refinancing may still be worthwhile without this outcome if the new loan helps you satisfy other financial needs. Overall, refinancing could:
Lower Your Interest Rate
Interest rates aren’t at the all-time lows available at the start of 2021, but they’re still reasonable by historical standards. If your credit score has gone up or your debt-to-income ratio has gone down since you took out your home loan, you might land a more competitive interest rate on a refinance.
You may also want to refinance an adjustable-rate mortgage before the initial fixed-rate period ends to avoid the potential volatility of rate swings.
Adjust Your Loan Term
Refinancing to a shorter term — meaning you’ll pay your loan off with higher monthly payments in fewer years — can save you money on interest over the life of your loan term.
Your existing interest rate will help you decide whether refinancing to a shorter loan term is worthwhile. For example, if you already have an uber-low interest rate, you may be better off increasing payments on your existing loan instead of refinancing.
If you decide to increase payments toward your existing loan, make sure you know if your lender charges a prepayment penalty.
Alternatively, you could refinance to a longer loan term if you’re struggling to keep up with your monthly payments. While this approach will mean you ultimately pay more interest over your loan term, it could be a lifeline that helps you keep your house and free up monthly funds for other expenses.
Improve Your Finances
You can use a cash-out refinance to access some of your home equity. That money can help you consolidate debt or fund home renovations, among other potential uses.
“A lot of consumers have increased the amount of debt that they’re carrying outside of their mortgage,” says Al Murad, executive vice president of online mortgage lender AmeriSave. “A lot of people are just sitting on a mountain of equity, and when you look at it, if you have high-interest credit card debt that you’ve racked up, it may make a lot of sense to utilize that equity to pay off some debt.”
You can also access your home’s equity through a home equity line of credit or home equity loan, which have different pros and cons. A HELOC can be helpful if you don’t have an immediate financial need, but want easy access to funds.
Cons of Refinancing a Mortgage
You should reconsider refinancing if you’re not sure whether the costs (financial and otherwise) will outweigh the benefits. You should also be sure the refinance will help you achieve tangible goals. Potential drawbacks may include:
Too Much Cost
Refinancing isn’t free. Closing costs typically land between 2% and 6% of your loan amount. If you’ll pay more in closing costs than you’d save with the new loan, refinancing won’t be a good way to save money. That said, closing costs aren’t set in stone, and you may be able to reduce the cost of refinancing by shopping around.
“Don’t be afraid to negotiate,” Murad says. “My recommendation is talk to multiple lenders, get that loan estimate in hand, and then go deliver that to everyone that you’re shopping with and ask them to beat it.”
Misalignment With Other Goals
Carefully consider your financial picture and life plans before you refinance. For example, you might want to refinance an ARM to a fixed-rate mortgage before the rate adjusts. But if you’re likely to move before the end of the initial fixed period, a refinance probably isn’t worth the effort.
If you’re refinancing to a shorter loan term, make sure you’ll be able to keep up with the new monthly payment. If you’re refinancing to a longer term, make sure the monthly cost savings are worth the increased interest over the life of the loan.
Too Time-Consuming
Refinancing effectively requires that you gather documents, price shop among different lenders and negotiate. If you don’t feel prepared to take those steps right now, you may want to pause. Instead, you could think about other ways to save money and make a plan to refinance later on.
[SEE: Current Mortgage Refinance Rates]
How Do I Know if Refinancing Is Right for Me?
Some rules of thumb exist for mortgage refinancing. For instance, if you can reduce your interest rate by at least a single percentage point, refinancing is likely worthwhile. That said, whether refinancing is a good idea can depend on a slew of factors, including your credit score, DTI, financial goals and the nature of your existing mortgage.
If your credit score has improved and/or your DTI has decreased since you first bought your home, you could qualify for a more competitive interest rate on a refinanced mortgage. If you have an ARM that you want to be fixed-rate or an undesired co-signer on your loan, refinancing can allow you to make changes.
If you think refinancing could be a good fit, start exploring refinance options. Once you have loan estimates in hand, you can find your break-even point to determine if a refinance would pay off. You can also use a mortgage refinance calculator to get a sense of your potential savings.
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Pros and Cons of Refinancing a Mortgage originally appeared on usnews.com
