Pros and Cons of Refinancing Your Mortgage

November 11, 2016

With mortgage interest rates at historic lows, you might be wondering if you should refinance your mortgage. There are advantages to refinancing, but also some disadvantages. Let’s look at both.

Pros of Refinancing Your Mortgage

Lower monthly payment: One of the most common reasons for refinancing a mortgage is to reduce the monthly payment amount. If your income has decreased, or you simply want to spend your money on something other than your mortgage, a lower monthly payment alone may be reason enough to refinance.

Lower interest rate: A lower interest rate usually results in a lower monthly payment after a refinance, but the monthly payment amount depends on the amount of the loan. If you borrow more than the original mortgage amount, your monthly payment could actually be higher, even if the interest rate is lower. However, a lower rate coupled with no change in mortgage amount should result in savings of thousands of dollars over the life of the loan.

Combine debt: Another frequent reason for refinancing is to combine debt, especially a first and second mortgage.

Tap the equity: It is also common for homeowners to do a “cash out refinance,” where they use the equity they’ve built up to receive cash upon closing, which they can use to pay off debt, remodel their home, or spend however they wish.

Remove mortgage insurance: Some homeowners find that they need to refinance to remove Private Mortgage Insurance (PMI) or FHA mortgage insurance.

Change terms of the mortgage: Some homeowners need to refinance to avoid terms of their current mortgage, such as an increase in interest rate for an Adjustable Rate Mortgage (ARM) or a balloon payment that’s coming due. Other homeowners want to change the length of their mortgage, such as from a 30-year mortgage to a 15-year mortgage, or vice versa.

Cons of Refinancing Your Mortgage

Cost: Refinancing can be expensive, since closing costs usually are 3% to 6% of the loan’s principal, or several thousand dollars (though these costs can generally be rolled into the new mortgage so you do not have to pay them upfront). There may also be tax consequences of refinancing that could cost you in April.

Effort and time: Do you remember how much work your original mortgage was? A refinance may not require quite as much effort or time, but you will have to fill out paperwork, sign escrow documents, possibly have your home appraised, and so on.

Factors to Consider

How long you plan to stay in your home/How long it will take to recoup closing costs: The length of time you plan to keep your mortgage has a huge effect on how much money you will end up saving. As discussed above, you will have to pay closing costs to refinance your mortgage. You’ll want to make sure you keep your new mortgage at least long enough to recoup those costs, and the longer you plan to keep the mortgage, the greater your savings will be.

Whether a Home Equity Loan or Line of Credit might be a cheaper alternative: Because of the costs involved in refinancing a mortgage, you might find that a Home Equity Loan or Home Equity Line of Credit (HELOC) might be more cost-effective, especially if you are looking to refinance for short-term reasons, such as a temporary loss of income or to pay for a remodel.

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