The Pros and Cons of Refinancing Your Mortgage

The Pros and Cons of Refinancing Your Mortgage
27th Mar 2024
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Refinancing your home loan offers a number of advantages, including the ability to cash out some of your equity or interest expense savings. If your long-term savings easily outweigh the initial costs and your credit is solid enough to get you a good rate on a new loan, refinancing is particularly helpful.

Yet it's not always beneficial to refinance. It's possible to obtain a larger loan with a longer payback period, which would result in higher monthly payments or more debt. Ultimately, there are times when mortgage refinance makes sense, and there are other cases where it might be best to wait and reconsider.

Pros of Refinancing

Refinancing may provide you with a number of benefits, depending on the type of loan you qualify for. These benefits include:

Repay Your Debt More Quickly

Your mortgage may be refinanced into a new loan with a shorter duration. Say, from a 30-year loan to a 15-year loan. You will pay off the loan faster and accumulate greater equity in the house if you decrease the loan term. This implies that you'll get your house free and clear sooner and enjoy perks like lower interest costs and greater monthly income since you don't have to pay a mortgage.

Eliminate PMI (Personal Mortgage Insurance)

To safeguard the lender from the possibility that you won't make your payments, you'll probably need to obtain private mortgage insurance (PMI) if you apply for a traditional house loan and put down less than 20% of the property's worth. PMI can raise your monthly mortgage payments by several hundred dollars.

However, you might now have at least the 20% equity required to avoid PMI if the value of your house has increased and you may have also paid off a portion of your loan sum. This implies you can eliminate PMI and refinance to a new loan, calculating your equity based on the increased worth of your house.

Payments Can Be More Predictable

You can refinance into a fixed-rate mortgage if you currently have an adjustable-rate loan. Your interest rate on an adjustable-rate loan fluctuates over time in response to changes in the market. It can therefore increase or decrease, and your monthly payment will also fluctuate.

Your interest rate is fixed for the duration of the loan when you have a fixed-rate loan. Since your total principal and interest payment will be constant, this increases the predictability of your monthly payments. Keep in mind that your escrow payment may change in response to changes in the cost of insurance and property taxes.

Ability to Redeem a Part of Your Equity

With a cash-out refinance, you can take out a larger loan and receive cash for the difference between the amount of your old and new loans. That can be useful if you want to finance your child's college education or pay off high-interest debt, such as credit card debt. To be eligible, you must have equity in your house. A cash-out refinance is only wise if the refinance mortgage loan will result in a cheaper rate than it was previously.

Flexibility to Modify Loan Features

By refinancing to a longer loan term, you can earn a cheaper monthly payment or save money by refinancing to a shorter loan term. A fixed-rate mortgage is a more appealing option if rates are predicted to rise. You might also convert from an adjustable-rate mortgage to a fixed-rate mortgage.

Cons of Refinancing

Refinancing your mortgage is not an easy task. The possibility of cost is just one of the remaining drawbacks. Here are the barriers to be mindful of:

Final Expenses

Closing costs associated with a mortgage refinancing typically range from 2% to 6% of the new loan amount. These costs consist of origination, appraisal, legal, and other fees. Depending on the lender you select, you may be able to negotiate a reduction in some fees.

To get the best terms, it's a good idea to compare offers from several refinance lenders, including the one you currently have your mortgage with.

Possibility of Debt

It's essential to weigh the short- and long-term benefits of refinancing before opting for a cash-out refinance or extending the loan payback time. If you refinance to a longer-term loan, you may end up paying more overall for your mortgage loan due to interest costs, even though your monthly payments will be lower. Furthermore, your debt-to-income ratio will increase if you take out a larger loan as part of a cash-out refinance, which could make payments more challenging or make it more difficult to borrow additional money in the future.

Your Home Equity Could Decrease

You can take out a loan against the equity in your house with a cash-out refinance. This implies that you are utilizing your home's equity, which will lower it. Thus, if you have $60,000 in equity in your house and you cash out refinance for $30,000, you will still have $30,000 in equity.

Minimal Savings and Consideration of Effort

Refinancing may not result in significant savings, so you'll need to weigh whether the effort and time required to refinance your loan are worth it. It will still take work on your side to apply for the new loan, provide financial documentation, and obtain an appraisal, even if the procedure is efficient and painless.

Should Your Home Loan Be Refinanced?

Considering whether to refinance your home loan depends on a few key factors:

  • Good Credit: If you have a credit score of 670 or higher, refinancing might be beneficial, especially in a market with rising interest rates. Improved credit since you first got your loan is also a good reason to consider it.
  • Savings Potential: Compare your current interest rate with the new rate you qualify for. If the new rate is at least 0.5% lower, refinancing could save you money. Make sure the savings offset the closing costs within a reasonable time.
  • Improving Financial Health: Refinancing can be a good idea if it improves your financial situation. Switching to a fixed rate, eliminating PMI, or adjusting co-borrowers are examples.

However, refinancing may not be suitable if:

  • Savings Aren't Significant: If the interest rate reduction isn't substantial or your financial situation doesn't allow for shorter repayment terms, refinancing may not save you money in the long run.
  • Affordability Concerns: If you're struggling to afford your current monthly payments, refinancing may not solve the problem. Instead, consider requesting a mortgage modification from your loan servicer.
  • Recent Home Purchase: If you've recently bought your home, you may not be able to refinance yet due to restrictions. Wait at least six months before pursuing a cash-out refinance, and longer for certain types of modifications.

The Bottom Line

The benefits and drawbacks of refinancing will vary from person to person, depending upon the specific circumstances and objectives. Consider your reasons for wanting to refinance, how long you want to stay in the house, how much interest rates will change, and whether doing so will benefit you as you try to decide whether to refinance your mortgage. It’s wise to talk to expert refinance mortgage lenders Michigan before you make your decision.

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