3 Disadvantages of Refinancing a Mortgage, and When It’s Worth It
Is there a downside to refinancing?
Refinancing involves replacing your existing mortgage with a new one. This can lower your interest rate and your monthly payment, and potentially save you thousands of dollars.
But at the same time refinancing has its advantages, it is not the right choice for everyone. A refinance restarts your loan. And there are also closing costs to consider.
Some people just focus on the new rate and the new payment. However, for refinancing to make sense, you have to look at the big picture and make sure you’ll save for the long term, not just month to month.
Check your eligibility for refinancing (January 20, 2022)
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Three things to know before refinancing
Besides getting a lower rate and monthly payment, other common reasons to refinance a mortgage may include changing loan programs or products, cashing out your home equity, or remove a person’s name from the loan.
But even if you have a good reason to refinance, make sure you understand how it works. There are a few inherent drawbacks to refinancing that will impact your decision.
Hee is what you need to know.
1. Refinancing restarts your loan
Since refinancing replaces your current mortgage with a new one, it starts the loan over. And in many cases, borrowers reset the clock with another 30-year term.
Starting a new 30-year loan term can provide the biggest monthly savings. Still, it’s not always the smartest decision, depending on the number of years remaining on your existing mortgage.
If you’ve had the original loan for five, 10, or even 15 years, starting over with a new 30-year mortgage means you’ll be paying interest on the home for a total of 35 to 45 years. This could increase the total amount of interest you pay over the term of the loan, even if your monthly payments go down.
Of course, that doesn’t always happen.
Some people receive a repayment date similar to that of their original loan. For this to happen, you need to refinance in the shorter term.
Let’s say you’ve already had the original mortgage for five years. Instead of another 30 year mortgage, you can refinance into a 15 or 20 year mortgage. Or, if you had the original loan for 20 years, you could refinance to a 10-year mortgage.
Just note that short-term loans almost always have higher monthly payments. This is because you have to repay the same loan amount in a shorter period of time.
But, as long as your new interest rate is low enough, you should see significant overall savings with a shorter loan term.
Check your eligibility for refinancing. Start here (January 20, 2022)
2. Refinancing costs money
Do you remember paying closing costs when you bought your house?
Sadly, refinancing also involves closing costs. These vary, but are usually between 2% and 5% of the loan amount. Closing costs are due at closing and may include:
- The origination fees of the lender
- New home valuation
- Registration fees
- Discount points
- Prepaid taxes and home insurance
- And more
Generally speaking, refinancing only makes sense when your savings outweigh your closing costs. This is the “break-even point”.
For example, let’s say the refinance reduces your monthly payment by $300 per month and you pay $6,000 in closing costs. You must hold the new mortgage for at least 20 months to break even.
The good news is that you can often build closing costs into your mortgage to avoid paying up front, but only if you have enough equity.
Some lenders even offer refinances with no closing costs, where you pay nothing (or very little) out of pocket.
The lender gives you credit for your fees, but it’s not technically free. In exchange for refinancing with no closing costs, you’ll likely pay a higher mortgage rate.
3. You could pay more in the long run
Yes, refinancing can provide you with immediate monthly savings by reducing your mortgage payment. But he is not it always offer long-term savings.
For example, if you’re almost done paying off a 30-year loan and you’re starting over with a new 30-year term, you’ll pay a lot more interest in the long run.
And your new interest rate and loan term aren’t the only factors that affect the overall cost. the quantity of your new mortgage also plays a role.
Refinancing by collection is another common reason to replace a mortgage. It involves borrowing money against your equity to improve your home, consolidate debt, and for other purposes. In this case, your new mortgage balance will exceed what you currently owe.
Now, if you start over with a new 30-year term and a lower rate, even with a larger balance, you could save monthly. But you’ll pay more in the long run, not only because you’ve borrowed more, but also because you’ve extended the overall term of the loan.
Before application, use a refinance calculator to estimate your savings and costs.
You can avoid paying more by not touching your equity and keeping your new payment date similar to the original one.
Sometimes, however, paying more is the lesser of two evils.
The bottom line is that refinancing can provide wiggle room in your budget and free up money for other purposes. So if you’re struggling to pay your current mortgage payment or meet other financial goals, the immediate savings could keep your head above water.
Check your eligibility for refinancing. Start here (January 20, 2022)
When is it a bad idea to refinance?
To sum up, refinancing isn’t always a good idea, even if you can get a lower mortgage rate.
Here’s a glimpse of when he maybe not makes sense to refinance a mortgage.
- You won’t keep the mortgage long enough to break even
- You cannot get a lower interest rate
- You have problems with your credit score or credit history and cannot qualify
- You are about to pay off the original mortgage
- You’ll pay a lot more in the long run
- You can’t afford the closing costs
- You cash in your capital for the wrong reasons (holidays, shopping, etc.)
Remember that refinancing must have a net financial benefit. If a mortgage refinance doesn’t improve your financial situation one way or another, it’s probably not worth it.
When is it worth refinancing?
Despite the inherent drawbacks – for example, having to start your loan over again – refinancing is often worth it. Especially at today’s near-record low interest rates, millions of homeowners could save on their housing costs.
Here are scenarios where it is often a good idea to refinance.
- You can reduce your monthly mortgage payment
- Your new rate is 1% or more lower than your current rate
- Your credit profile has improved and you can get a loan at a reduced rate
- You want to switch from an adjustable-rate mortgage to a fixed-rate mortgage
- You want to switch to another loan program (for example, from an FHA loan to a conventional loan without PMI)
- You plan to hold onto the mortgage long enough to break even on your closing costs
- You can pay closing costs up front
- You want to eliminate FHA or USDA mortgage insurance
- You want to reduce or increase the duration of the loan
- You want to leverage the equity in your home
- You remove a name from the mortgage
There are many ways a mortgage refinance can benefit you. In addition to saving you money each month, refinancing could help you consolidate debt, pay for home renovations, pay off your house sooner, and more.
If you’re on the fence, talk to a mortgage counselor or loan officer who can help you explore your loan options and decide if refinancing is worth it.
The Bottom Line: Should You Refinance?
Refinancing can lower your mortgage rate, your monthly payment, and provide cash from your principal. Just be sure to consider the overall financial picture before applying.
You need to consider savings as well as refinancing costs, both short-term and long-term.
- How long will it take to break even?
- How long do you plan to live in the house?
- How long is the new mortgage term?
- Are you going to pay more or less interest overall?
As long as you calculate the numbers beforehand, refinancing can be a great decision. Many homeowners save thousands, or even tens of thousands, by refinancing at a lower rate.
Check your new rate (January 20, 2022)