What Are the Pros and Cons of Refinancing Your Home?

One of the major reasons homeowners choose to refinance is to secure a better interest rate. A lower interest rate can save you thousands of dollars over the life of your loan, as well as reduce your monthly mortgage payments. 

This is especially beneficial if your credit score has increased since you first applied for a mortgage. With a higher credit score, you’ll qualify for the best rates and terms and save money on your loan. 

In addition, refinancing can provide the means to switch from an adjustable-rate mortgage (ARM) to a fixed-rate mortgage. Doing so will ensure that your monthly payments remain the same throughout your loan term, which can make it easier to plan your budget. 

Mortgages typically come in 15-year and 30-year terms, with most buyers opting for 30 years to spread out the cost and reduce their monthly payments. Refinancing your home can reduce your loan term. 

For example, you might consider refinancing your 30-year loan with a 15-year loan. Alternatively, you might secure a new mortgage with no prepayment penalty, allowing you to make extra payments and pay off your mortgage as quickly as possible. 

Why would shortening your loan term be an advantage? For one thing, you’d get out of debt much sooner. Once your mortgage is paid off, you’ll have a lower debt-to-income ratio, which can help you qualify for future loans for cars or even retirement and investment properties.  

Also, by paying off your loan sooner, you’ll save thousands of dollars that you’d otherwise pay in interest. 

When you bought your home, did you have enough to make the traditional 20% down payment? If not, then you’ve been strapped with private mortgage insurance (PMI). 

The average PMI payment ranges between 0.5% to 2% of the original loan amount. Lenders typically roll these fees into your regular monthly payments, so it’s possible you’ve even forgotten about these fees. 

When you refinance, your new loan will calculate the equity in your home based on its current value. If you have 20% equity, refinancing will allow you to eliminate PMI fees, shaving some money off your monthly payments — in addition to any savings you might secure with a lower interest rate. 

Do you need extra cash? A cash-out refinance allows you to tap into your home’s equity to get it. With this refinancing strategy, you’ll take out a loan that’s larger than you need for the home itself. The additional money can then be paid to you in cash. 

The advantage is that there are no restrictions on how you use the loan. You can pay off credit card debt, student loans, fund your children’s education, or even make home improvements that increase your home’s value. 

Just be sure that your new loan also offers a lower interest rate. Otherwise, the cash you receive will be offset by the money you pay in interest over the life of your new loan. And this refinancing option only works for homeowners who have some existing equity in their homes, with most lenders looking for at least 20%. 

Remember the closing costs you paid when you first purchased your home? When you refinance your mortgage, you’ll have to pay closing costs all over again. These can include appraisal fees, attorney fees, filing fees, and all the other expenses that go into buying a property. 

Closing costs don’t have to be a barrier to refinancing, but it’s important to run the numbers and ensure that the benefits of refinancing outweigh the cost of going through the process. For instance, if refinancing your home will only save you a small amount, it may not be financially worth it. 

A shorter loan term is a great idea for getting out of debt. But the shorter your loan term, the higher your monthly payments. 

Before you refinance your home, be sure that your finances are stable enough that you can afford to make larger mortgage payments each month. Leave yourself some breathing room for emergencies and unforeseen expenses as well, or you could find yourself missing payments and paying penalties. 

While evaluating your eligibility for refinancing, a lender will perform a hard credit inquiry to view your credit history. These inquiries can reduce your credit score, at least on a short-term basis. 

These sorts of dips in your credit score are marginal and will quickly improve once you make timely payments on your new loan. But a drop in your score might jeopardize your eligibility if you’re also applying for other financing products in the same general period.