Purchasing a home for the first time can be an exciting experience. You may have locked-in a decent interest rate for your mortgage and are enjoying all the benefits of home ownership. Then the interest rates dropped a few years later. Suddenly, what you felt was a competitive interest rate for your mortgage is now extremely high in the current market.
That opens up the possibility of refinancing your home. When you refinance, you are terminating your first mortgage and starting a new one. This process allows you to take advantage of the current interest rates in the market to potentially reduce your monthly payments without changing the equity you’ve built into your home.
As with any large purchase or financing decision, there are risks involved during this process. That is why it is so important to consider all the pros and cons of refinancing your home before you sign on the dotted line.
List of the Pros of Refinancing Your Home
1. You can lower your interest rate.
You could choose to refinance your home at a higher interest rate than your current mortgage if you decide to pay off some debt or use the equity in some way. Most homeowners, however, use the refinancing process to lower their interest rate. On a standard $250,000 mortgage, which is near the median home value in many communities in the United States, dropping a mortgage interest rate by two percentage points could save up to $300 per month in payments.
2. It allows you to convert the mortgage to a new structure.
Some homeowners take advantage of the lower payments that are available with an adjustable rate mortgage to get into their first home. When the time for an interest rate adjustment occurs, the refinancing process can eliminate the uncertainty of that mortgage type by going to a fixed-rate option. If you purchased a home thinking that you’d only be there a short time, then changed your mind, then refinancing off the ARM is a good idea.
3. You can cash out on your equity.
If you have equity in your home, then you have a difference between the worth of your home and what you owe on your mortgage. Instead of selling your house to cash out on this equity, a refinance can help you to do that if you’re not ready to move. You can then use the additional money to improve your property, pay for school, or just pay off your debt. Doing this may increase your mortgage payment and create other negatives, so take a thorough look at your finances before proceeding.
4. Some fees can be rolled into the refinanced mortgage.
There can be extensive fees involved with the refinancing process. The total amount due at the end of the process may be more than some homeowners may be comfortable paying. Some lenders will roll most, if not all, of the required fees to refinance your home into the new loan.
5. It can provide you with more options for the loan.
Many homeowners used a national lender when originating their mortgage because of how convenient the process happens to be. If you are thinking about refinancing your home, you can shop around a bit more than when you originated your first mortgage. You can also stay local with the application process. Working with a local lender will often help you achieve a lower rate than if you work with a national provider.
6. You have more leverage on the final terms of your loan.
In the United States, all lenders are required to provide an estimate of what you’ll face in fees to complete the refinancing process. Because of this requirement, you can solicit multiple offers from lenders without a hard credit search, which would impact your score negatively. By negotiating the various fees which can be legally present on a refinance, you could save more than $1,000 on the cost of the loan before you even begin the full application process.
7. It allows you to merge multiple mortgages into one product.
For homeowners carrying a second mortgage, a home equity loan, or a similar financial product, the advantage of refinancing your home is that you can merge all these products into one simple mortgage. Most home equity loans and additional mortgages come at a higher interest rate because they have more risk associated with them. You’ll be able to save a bundle on a successful refinance through lower interest rates, which could mean tens of thousands of dollars in your pocket over the full life of the loan.
List of the Cons of Refinancing Your Home
1. It is based off your current credit profile.
If there have been changes to your credit history or your income since you first took out a mortgage, the refinancing process may not be as beneficial as you think it may be. If there has been a bankruptcy in the past 5-7 years, it can even stop the refinancing process completely. For those who have seen their credit scores go down, the interest rate offer on the new mortgage may be higher than what is being paid right now. To get the best rates available, a credit score of 720 is likely required.
2. You are not guaranteed a refinancing offer.
You may have been approved for a mortgage. That does not mean you’re guaranteed to receive a refinancing offer. Some homeowners may present to much of a risk to lenders. To determine if you qualify, you may be asked to provide numerous corroborating documents, including your current tax returns, recent paychecks, or verification of self-employment income before your request will even be considered.
3. There are refinancing costs you’ll need to pay.
Refinancing a home is not a free process. There are costs to pay with a new loan, which can be as much as 6% of the loan balance being considered. There are fees that come with the refinancing process as well, such as an application fee, a home appraisal fee, and a loan origination fee. You may even be asked to pay discount points, even if you weren’t asked to do so during the first mortgage.
4. There may be a private mortgage insurance upfront payment.
If you are a homeowner with an FHA loan, then you may be asked to pay an upfront fee for the mortgage insurance that would be required for the loan. Mortgage insurance is a policy that rides on your mortgage that offers a guarantee for the lender. If you are unable to fulfill your obligations on the loan, then the insurance reduces the financial risk to the lender should a default occur. Depending on your creditworthiness or the amount of a down payment you may be able to pay, the PMI could be up to 2% of the loan upfront.
5. Equity may be required to complete the process.
After the housing crunch happened in 2007-2009, many homeowners found themselves in a home that was worth less than the mortgage they were paying. That prevented many of them from being able to refinance their mortgage because they had no actual equity in the home. One of the dangers of the refinancing process is that a home appraisal comes in lower than a previous appraisal. Should that occur, you may be asked to provide additional equity to originate the refinancing loan.
6. Many refinance loans are recourse loans.
You’ll want to look at the language of your current mortgage, then look at the language of your refinancing offer, to determine if there is recourse available to the lender. If a lender is allowed to pursue recourse, that means they can seize your assets if the sale of a foreclosed home does not cover the total amount of the loan. Some states may have laws regarding the recourse process which you’ll want to review as well. If you are thinking about switching from a non-recourse loan to a recourse loan, however, you’ll want to give the idea a second and third look before proceeding.
7. There will likely be prepayment penalties.
Many refinance products contain language which prevents you from performing another refinance for 2-5 years, depending on the lender. If you pay off the mortgage too early, you’ll face a penalty that would apply. Although a deep drop in interest rates may make paying a penalty worthwhile, the actual cost can be variable and may be too steep for some homeowners. Pay close attention to this issue if you are refinancing to a higher interest rate to cash out on the equity you’ve built into the home.
The pros and cons of refinancing your home make it possible to lower your monthly payments, which can keep some homeowners in their home. It may also be difficult to complete the refinancing process for some homeowners because of a change to their employment or credit score. For that reason, it is important to shop around, be aware of your financial history, and make a long-term decision which benefits your family.