Refinancing, or paying off a home loan early, is a typical move that can save you a considerable amount of money over the life of the loan, and the interest rates are low enough to make it a tempting option. But, as with any other financial decision, it's essential to do your research and understand the pros and cons of refinancing to make a well-informed decision.

With the housing market showing signs of life with low interest refinance rates, some wonder if now is the time to refinance their homes. But are they really buying more bang for their buck? Does refinancing save you money? Does it make you more secure? 

To answer your questions, you need to understand what refinancing entails and know the alternative you have., so let's take a look at the most important things to consider before determining if refinancing is for you or not. 

 

What Does it Mean to Refinance Your Home?

Refinancing is a term used to describe taking out a new mortgage on your home and either replacing the current one that you have, or adding a subordinate one. 

It sounds simple, but it is actually a fairly complex process. There are a lot of factors that go into refinancing your home, including the amount of equity you have in your home, i.e., your credit score at the time of application and how much of your loan you've already paid off.  

Refinancing may appear to be a good idea on paper, but it does not always put you in a great spot. It's best to balance the benefits and drawbacks while considering your situation.

 

Pros of Refinancing

1. Secure Lower Interest Rates.

Refinancing into a mortgage with a better rate will almost always be a sensible option because it not only reduces your monthly payment, but it'll reduce the amount of interest you're paying over the life of your loan.

This is especially handy if the new rate is much lower than the old one. As a general rule of thumb, if you plan to refinance purely to lower your rate, then you should only be refinancing if your rate is being lowered by at least 0.375%. 

If you purchased your house recently, the refinanced rate might not be low enough to persuade you to refinance. However, if you took out your first mortgage more than a decade ago, you could save hundreds of dollars by switching to a new rate and removing any mortgage insurance on your existing loan (more in a little bit).

2. Cut Down Your Monthly Payments.

By refinancing into a new rate, you may be able to cut your monthly payments. Let's imagine you have 10 years left on your first mortgage and decide to refinance for a lower rate into your 10-year term. 

Your monthly payment will most likely decrease. You'll save even more per month if you refinance into 15 years because you're stretching the same loan principal out over a lengthy span of time.

Keep in mind that if you spread your mortgage payments out over a more extended period, you'll be paying your mortgage for a longer period. However, depending on your objectives, you may find it worthwhile.

3. You Can Speed Up The Repayment of Your Mortgage.

Maybe your original mortgage term was 30 years, and you're only 20 years into it. You will pay off your mortgage five years sooner if you refinance into a 15-year mortgage.

Not only are interest rates currently at historic lows, but lenders also offer far lower and cheaper rates for shorter terms. The shorter the term, the better the rate in almost all scenarios.

4. Eliminate PMI

There is a good chance you're paying private mortgage insurance (PMI) on your home loan if you did not put down 20%+ for your mortgage. You can ask your lender to cancel your PMI when you have 20% equity in your home, but note that they aren't required to do so and it's a little tricky.

However, Private Mortgage Insurance (PMI) will be canceled if you own 22% equity in your home based on original purchase price value or (in some cases) market values.

But if you have a long way to go before you have 20% or 22% equity on your home, you may be able to refinance and get rid of PMI altogether. No PMI will be required for the new loan, as long as your refinanced mortgage loan to value ratio is under 80%. Once PMI is removed, you'll save significantly more on your monthly payment. PMI is a little confusing to understand which is why we always recommend speaking with a Mortgage Loan Expert for guidance on your specific scenario.

5. Refinancing Can Help Convert to an Adjustable Rate Mortgage.

Even if they begin lower than fixed-rate mortgages, the periodic rate adjustments associated with ARMs may result in larger rate increases than those related to fixed-rate mortgages. Switching to a fixed-rate mortgage avoids future interest rate increases and saves money over time.

To save money on refinancing, homeowners who do not intend to stay in their homes for an extended period of time may wish to change from fixed-rate loans to adjustable-rate mortgages (ARMs).

However, they will not have to worry about rising rates in 30 years, which will result in lower monthly payments and interest rates.

Periodic rate adjustments result in a lower rate and a lower monthly mortgage payment with an ARM. Refinancing every time interest rates fall is, however, superfluous. If mortgage rates increased, this would be a terrible idea.

 

Cons of Refinancing

1. There are Costs Involved.

The financial outlay of refinancing is by far its biggest drawback. Because you're getting a new loan to pay off the old one, you'll have to pay many of the same loan fees you did when you bought the house in the first place. These fees typically include origination fees ($0 with X2 Mortgage), title insurance, escrow fees, prepaids, and any remaining closing costs.

Be careful with which lender you work with as some are notorious for increasing their margins by offering a low interest rate and making up for it in a massive amount of cost to you.

A new appraisal might also be necessary as well (depending on your situation). Property value is a major driving factor with a refinance and if an appraisal waiver isn't received from the Automated Underwriting System, then you'll need to be prepared to pay for an appraisal as well. 

According to the Federal Reserve, closing costs on a refinance can cost anywhere from 1% to 4% of your initial loan amount, depending on where you live. However, most borrowers pay somewhere in the middle of that range. To make refinancing worthwhile, you must be certain that you will save enough money as a result of the transaction.

2. Payments Could Be Higher Every Month.

Refinancing into a shorter-term loan can assist you in paying off your debts more quickly. However, keep in mind that this will increase your monthly payments. If your present mortgage has 20 years left on it, a refinance allows you to compress the same amount of loan principal into a shorter period. 

As a result, you must make greater monthly payments to pay off the same amount faster. However, your monthly payments may not increase if you refinance for the same or a longer-term.

3. Increasing the Length of Your Term Will Cost You Money.

You may consider refinancing into a 30-year mortgage if your existing mortgage has 20 years remaining. Ten years will be required to repay your loan, which results in a lower monthly payment for you.

This is, however, a costly route to take. If you extend your mortgage by ten years, you will be responsible for an additional ten years of interest on the principal, which might add up.

You may still decide that refinancing to a longer-term is worth the expense. But keep in mind the situation you're putting yourself into.

 

Is Refinancing Right For Me?

This question has no apparent right or wrong response for everyone. As with any big financial decision, the decision to refinance your mortgage is highly dependent on your financial status and goals.

However if rates are low, if your credit is excellent, if your household has a stable income, and you still owe a large amount on your present mortgage, a refinance may be worthwhile.

There are several reasons why homeowners remortgage. Interest rates, pulling equity from your home, the length of time you intend to stay in your house, and saving money are all factored into the decision-making.

Savings from refinancing may take months or even years to offset refinancing costs. Therefore, before refinancing, you should be mindful of the time required to break even.

 

Alternative Options to Refinancing a Mortgage

Refinancing a mortgage is certainly an option — but many alternatives are also worth exploring, each one will have a different cost and setup, so it's important that you choose the right type of loan for your situation.

1. Try Recasting Your Mortgage.

Instead of a refinance, reach out to your current mortgage servicer to see if a recast is in the cards for you. A recast is not a refinance but instead when you choose to reamortize your loan over the term of your original loan. For example, if you took out a 30 year loan and are 10 years into it (meaning the balance is far lower) - You can recast it to lower your payment.

That new loan balance after 10 years of paying it down will be re-strung out over 30 years, ultimately lowering your payment.

Most mortgage companies will recast your loan once in its lifetime. It's important to have caution when doing this as it can significantly increase the time it takes you to pay off your mortgage and be debt free. 

2. Make an Application For a Home Equity Line of Credit (HELOC).

With a home equity loan or line of credit, you can borrow money against your home's equity. Then you repay it over a specified amount of time, such as 30 years, in monthly installments. It is comparable to a conventional mortgage in that it provides cash rather than a loan. As with a cash-out refinance, it enables you to borrow against your home's equity.

The contrast between a home equity loan and a cash-out refinance is that the former is a second mortgage. While a cash-out refinance eliminates the need for a first mortgage, a home equity loan adds a second mortgage payment to your monthly costs.

Although a home equity loan has a higher interest rate than a cash-out refinance, the closing costs are lower.

A HELOC may be a fantastic option if you've built up equity in your house and wish to borrow money as needed; however, the rate is frequently higher than a cash-out refinance.

 

Wrap Up: Consult an Expert on if Refinancing is Your Best Option

It's not surprising that there are reasons for caution in refinancing. There are many factors to consider, from the amount of debt you have to your interest rate, which should be the largest factor in deciding whether a refinance is a good idea for you. 

Each borrower will have their own unique experience based on their current situation, current mortgage, current financial situation, current credit rating, and personal risk tolerance. If you are considering refinancing and still confused, you should consult with a professional who can help you weigh the pros and cons of refinancing to make an informed decision.