Is there a downside to refinancing?
Refinancing replaces your existing mortgage with a new one. This can lower your interest rate and monthly payment, and potentially save you thousands.
But even if refinancing has its advantages, it is not the right choice for everyone. A refinance starts your loan from scratch. And there are also closure costs to consider.
Some people just focus on the new tariff and payment. However, for refinancing to make sense, you need to look at the bigger picture and make sure you are saving in the long run – not just month to month.
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Three Things You Should Know Before Refinancing
In addition to a lower interest rate and monthly payment, other common reasons for refinancing a mortgage could include switching loan programs or products, paying off your home equity, or removing someone'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 couple of inherent drawbacks to refinancing that will affect your decision.
Hee is what you should know.
1. With the refinancing, your loan starts all over again
Since the refinance replaces your current mortgage with a new one, the loan starts over. And in many cases, borrowers postpone the clock with another 30-year term.
Starting a new 30 year loan term can offer the greatest monthly savings. However, this isn't always the smartest move depending on the number of years your existing mortgage remains in place.
If you've had the original loan for five, 10, or even 15 years, starting over with a new 30-year mortgage will mean paying interest on the house for a total of 35 to 45 years. This could increase the total amount of interest you pay over the life of the loan – even if your monthly payments go down.
Of course, this doesn't always happen.
Some people are given a payout date that is similar to their original loan. To do this, you need to refinance into a shorter term.
Let's say you have 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 have had the original loan for 20 years, you can refinance into a 10 year mortgage.
Just keep in mind that short term loans almost always have higher monthly payments. That's because you need to repay the same loan amount in less time.
However, as long as your new interest rate is low enough, you should see significant overall savings with a shorter loan term.
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2. Refinancing costs money
Do you remember paying the closing costs when you bought your home?
Unfortunately, there are acquisition costs associated with refinancing. These vary, but are usually between 2% and 5% of the loan amount. The acquisition costs are due upon acquisition and can include:
Lender Creation FeeNew Property Appraisal Admission FeesDiscount PointsPrepaid Taxes and Home InsuranceAnd more
In general, refinancing only makes sense if your savings outweigh the 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've paid $ 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 add closing costs to your mortgage loan to avoid paying upfront – but only if you have enough equity.
Some lenders even offer no closing fee refinancing where you pay nothing (or very little) out of your pocket.
The lender will give you credit for your fees, but it is technically not free. In return for a refinancing with no closing costs, you will likely pay a higher mortgage rate.
3. You could pay more in the long run
Yes, refinancing can result in instant monthly savings by lowering your mortgage payment. But it doesn't always offer long-term savings.
For example, if you've paid off a 30-year loan almost in full and start over with a new 30-year term, you'll be paying much more interest in the long run.
And it's not just your new interest rate and your repayment term that affect the total cost. The size of your new mortgage also plays a role.
Cash out refinancing is another common reason for a mortgage replacement. This includes taking cash out of your equity for home improvement, debt consolidation, and other purposes. In this case, your new mortgage balance will exceed your current debt.
If you start over now with a new term of 30 years and a lower interest rate, you can save monthly even with a higher credit balance. But you'll pay more in the long run – not just because you've borrowed more, but also because you've extended the overall life of the loan.
Before you apply, use a refinancing calculator to estimate your savings and costs.
You can avoid paying more by not touching your equity and by keeping your new payout date similar to the original one.
However, sometimes the lesser evil is paying more.
The bottom line is that refinancing can create room for maneuver 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 instant savings can keep your head above water.
Check your refinancing eligibility. Start here (7.09.2021)
When is refinancing not useful?
In conclusion, refinancing is not always a good idea – even if you are getting a lower mortgage rate.
Here's a look at when it doesn't make sense to refinance a mortgage loan.
You won't hold the mortgage long enough to get profitabilityYou can't get a lower interest rateYou have problems with your creditworthiness or credit history and cannot qualifyYou are about to pay off the original mortgageYou will pay much more in the long runYou may lose the closing cost You are collecting your equity for the wrong reasons (vacation, shopping, etc.)
Remember that the refinancing must have a net financial benefit. If mortgage refinancing doesn't improve your financial situation in any way, then it's probably not worth it.
When is refinancing worthwhile?
Despite the inherent disadvantages – for example, having to start your loan over – refinancing is often worthwhile. Millions of homeowners could save their housing costs, especially with today's record-breaking low interest rates.
Here are scenarios where refinancing is often a good idea.
You can lower your monthly mortgage paymentYour new interest rate is 1% or more below your current interest rateYour credit has improved and you can get a cheaper loanYou want to switch from a variable rate mortgage to a fixed rate mortgageYou want to switch to a different loan program (ex. from an FHA loan to a traditional no PMI loan) You plan to hold the mortgage long enough to cover your closing costsYou can afford the closing costs upfrontYou want to eliminate FHA or USDA mortgage insuranceYou want to shorten or extend the repayment periodYou want to add to your home equity remove a name from the mortgage loan
There are many ways that you can benefit from mortgage refinancing. In addition to saving you money every month, a refinance can help you consolidate debt, pay for home improvements, prepay your home, and much more.
When you're on the fence, speak to a mortgage advisor or loan officer who can help you explore your loan options and decide whether it's worth refinancing.
The Bottom Line: Should You Refinance?
Refinancing can lower your mortgage rate and monthly payment, and can provide cash from your equity. Just make sure you consider the bigger financial picture before you apply.
You need to consider both the savings and the cost of refinancing – both in the short and long term.
How long does it take to break even? How long do you want to live in the house? How long is the new mortgage term? Are you paying more or less interest overall?
As long as you crack the numbers first, refinancing can be a good decision. Many homeowners save thousands or even tens of thousands by refinancing at a lower interest rate.
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