If you refinance your home, or at least think about it, you’re in good company. The mortgage that you’ve got right now might not be the best you could get, especially if it’s been a while since you financed your home. But a refi isn’t guaranteed, and there’s a lot to consider before you take the plunge.
For every benefit, there’s likely a drawback. Here are some of the pros and cons that you’ll need to balance if you’re in the market for a new home mortgage:
Some of the Pros:
Refinance Your Home to Save Money
Probably the most common reason home owners want to refinance a loan is to save money. Saving only a point or two in your interest rate can add up to a dramatic savings over the life of the loan. For example, The Fiscal Times explains that a 1 percent reduction in interest rate on a $100,000 mortgage could yield a savings of as much as $20,000.
If you’ve had your mortgage for more than 10-15 years, chances are you could secure a 30-year fixed rate that’s remarkably better than what you have. It can mean paying less interest overall, and of course there’s the accompanying lower monthly payment, too. (Read: Home Mortgage Savings Tips)
Benefits of Refinancing Your Home
If you’re like many home owners, securing a loan with manageable terms was a feat and a test of your patience. But you’re in a different position now — you don’t have to refinance, which means you can shop around at your leisure without a looming date when you absolutely must close.
With that kind of flexibility, you have more time to think about what you want out of this chance to refinance your home. Here are the most common reasons for refinancing your home:
- Get a lower interest rate, with lower monthly payments.
- Pay off your mortgage faster with a shorter term loan, typically 15 years.
- Switch from a variable rate loan, to a fixed rate loan to avoid higher interest rates.
- Merge a first and second mortgage into one loan.
Enjoy the Equity in Your Home by Refinancing
In general, homes increase in value over time. Combined with the payments you’ve made through the years to reduce the amount you owe, you might have a great deal of equity in your home. Equity, simply put, is the excess value that your home has beyond what you owe on the note. If you owe $100,000, but your home is worth $150,000, that’s a lot of equity that’s not really benefiting you. But Money Crashers says you could access with a cash-out refi.
Refinancing isn’t your only option for banking the equity, though. There’s also a home equity line of credit (HELOC) and a home equity loan. With a HELOC, you would have an adjustable rate line of credit that you can draw against for future projects, when you're ready to stat them. With a home equity loan, you receive a lump sum. Essentially, the equity in your home acts as security for either of these options, and you make payments on them as you would any other loan. (Read: True Cost of Home Ownership)
Some of the Cons:
Watch out for High Refinance Fees
When you refinance a home, you can count on fees. Some banks occasionally have a fee sale. More often you'll find you're paying a few thousand dollars up front (rate lock, document, wire transfer, loan origination, etc.) to gain the savings from a lower interest rate for as long as you hold your mortgage.
Be sure your savings with a lower interest rate, are able to cover your fees in just a few years. This is where it helps to consider how long you expect to remain in your home. If you move every three to five years, it might not make sense to refinance your home. If you’ll be in your home for 10 or more years, there is a much larger benefit to justify the hassle of a refi.
There are lots of mortgage calculators online, to help you evaluate the cost of a mortgage. It's relatively easy to compare monthly mortgage costs between your current mortgage, and a new lower mortgage. However you also want to look at how many months it will take to recover all the fees associated with refinancing your home. This mortgage refinance calculator from BankRate.com, does just that. It helps in several ways:
- Identifies typical refinance costs to include in your calculations.
- Calculates your new monthly payment, along with monthly savings.
- Identifies how much you'll save in interest for the life of your loan.
- Most important, it tells you how many months you need to hold the new mortgage to recoup closing costs.
Understand the Risks When You Refinance Your Home
You want to understand the loan terms you have with your original mortgage. Most mortgages obtained to buy a house, use the house as collateral to secure the loan. The lender is allowed to seize the house if you fail to repay the loan, which we know as a foreclosure. While it depends on the state where you own property, most loans obtained when purchasing a home are non-recourse loans, that limit the bank to foreclosing on your house while protecting your other assets.
When you refinance your home, you may lose this protection with a recourse loan that allows the bank to seize other assets. So if your house loses value and isn’t worth what you owe and it’s foreclosed, it's more likely other assets you have are at risk if you've refinanced your home. In this case, the bank could seize more of your personal assets to cover the loss.
How to Get the Best Refinance Return
A refinance can usually save you money only if you plan to stay in the home for a while. A lower interest rate and lower monthly payments add up to savings over time. If you sell the house before you see a return, it’s probably a better option for you to keep the loan you have and hope to enjoy a return on your investment from the equity when it sells.
The Fiscal Times also reminds that fees factor into this situation. If your fees are high when you refinance your home, and you plan to sell within the next few years, you might barely break even.
Whether or not to refinance your home is a tough decision. There’s a lot more to think about besides the possibility of saving some money in the long run. And if the deal isn’t great, you might not save any money at all.
But some refi scenarios are definitely worth it. Maybe your credit wasn’t perfect when you bought your home. And now with a few years gone by, and with interest rates lower, the savings that you get from a lower rate could total well into the thousands. The bottom line is not to jump hastily into a refinance.
Have you recently refinanced your home? Is there anything you’d definitely do again? Or something you wish you hadn’t agreed to? Share your story below …