The Pros and Cons of Refinancing Your Mortgage

Refinancing your mortgage – it’s a term you hear a lot, especially when interest rates fluctuate. But is it the right move for you? Refinancing essentially involves taking out a new mortgage to replace your existing one. It can seem like a complex process, but understanding the potential benefits and drawbacks is crucial before you commit. Published January 19, 2020, this post explores what you need to consider.

The Good: Potential Benefits of Refinancing

Lower Interest Rate: This is often the primary motivation for refinancing. Even a small reduction in your interest rate can significantly decrease your monthly payments and the total amount of interest you pay over the life of the loan. As of early 2020, mortgage rates were relatively low, making refinancing particularly attractive.
Reduced Monthly Payments: A lower interest rate directly translates to lower monthly payments. This can free up cash flow for other expenses or investments.
Shorten Loan Term: If you currently have a longer-term mortgage (e.g., 30 years), refinancing to a shorter term (e.g., 15 years) can significantly reduce the total interest paid over the life of the loan. However, be realistic about your ability to comfortably manage higher monthly payments.
Change Loan Type: You might consider refinancing to switch from an Adjustable-Rate Mortgage (ARM) to a Fixed-Rate Mortgage for stability or vice-versa, depending on your risk tolerance and market predictions.
Remove Private Mortgage Insurance (PMI): If you’ve built up enough equity in your home, refinancing can allow you to remove PMI, further reducing your monthly payments.

The Bad: Potential Drawbacks of Refinancing

Closing Costs: Refinancing isn’t free. You’ll incur closing costs, which typically include appraisal fees, origination fees, title insurance, recording fees, and lender fees. These can range from 2% to 6% of the loan amount. It’s crucial to calculate whether the savings from refinancing outweigh these costs.
Break-Even Point: There’s a “break-even point” – the amount of time it takes for your savings to outweigh the closing costs. It's essential to understand this before committing. A longer loan term and higher closing costs will lengthen this break-even period.
Credit Score Impact: Applying for a new mortgage can temporarily lower your credit score due to the hard inquiry. Minimize the impact by comparing lenders and choosing a lender known for responsible credit reporting.
Market Conditions: Refinancing only makes sense if current interest rates are lower than your existing rate. If rates have risen, refinancing might actually increase your interest expense.
Debt Accumulation: Refinancing to a longer term can ultimately result in paying more interest over the life of the loan.

Is Refinancing Right for You?

Refinancing can be a smart financial move, but it’s not always the best option. Here’s a checklist to help you decide:

Check Current Interest Rates: Compare rates from multiple lenders.
Calculate Break-Even: Determine how long it will take to recoup your closing costs.
Assess Your Financial Situation: Can you comfortably afford higher monthly payments if you shorten your loan term?
Consider Your Long-Term Plans: How long do you plan to stay in your home?

Disclaimer: This blog post provides general information about refinancing mortgages. It is not financial advice. Consult with a qualified mortgage professional to discuss your individual circumstances and determine the best course of action.