Refinancing can be a great way for homeowners to reduce their mortgage payments, erase monthly mortgage insurance, or reduce their loan terms. While refinancing has some significant advantages, it’s not always a good idea for some homeowners.
Continue reading to find out how refinancing works, the pros and cons of refinancing, and how to decide if you should refinance your existing mortgage.
What Are The Benefits of Refinancing?
A simple way to think about refinancing is that you’re taking your existing mortgage and replacing it with a new one with better terms. Homeowners typically refinance to either lower their monthly payment or reduce the length of their mortgage.
Refinancing your mortgage also comes with several benefits:
Lower Your Interest Rate
Your interest rate determines your monthly mortgage payment, so it makes sense that reducing your interest rate also reduces your monthly payment and is the number one reason why homeowners refinance.
For example, a borrower with a loan balance of $250,000 and a 6% interest rate has a monthly payment of about $1,200. However, that same borrower with a 4% rate only pays $955 per month.
Lowering your interest rate through a refinance is only possible when interest rates in the market are lower than your current rate. This means if you locked in a 5% rate in 2019, you’d need to be able to refinance into a rate lower than 5% to save money on your mortgage payment.
Remove Your Mortgage Insurance Premium
If you took out a loan with the Federal Housing Administration (FHA), you must pay a mortgage insurance premium (MIP) each month as part of your monthly payment. Some borrowers with equity in their home may choose to refinance out of MIP by switching their loan type to conventional.
Turn Your Home Equity Into Cash
Cash-out refinances are a great way for owners to take advantage of the equity they’ve built in their homes.
Cash-outs are designed to give homeowners a lump sum of cash to use for various purposes, like home improvements. However, cash-outs are harder to qualify for and require you to have significant equity in your home.
Pay Off Your Home Early
In addition to lowering your interest rate, borrowers can also change the length of their loan through a refinance. Those in a 30-year traditional mortgage may want to shorten their term to a 15 or 10-year loan to reduce interest paid over time.
Switch to a Fixed Rate
Fixed-rate loans are mortgages with, of course, a fixed interest rate that doesn’t change throughout the life of the loan. Fixed-rate loans are ideal because you know exactly what your mortgage payment will be in the future since it doesn’t change.
However, some borrowers may choose an adjustable-rate mortgage (ARM) instead. ARMs have adjustment intervals that typically increase your interest rate and monthly payment. Borrowers who want to avoid these rate increases may refinance their mortgage into a fixed-rate loan that doesn’t adjust.
What Are The Drawbacks of Refinancing?
While refinancing comes with some important benefits, there are some drawbacks that you should be aware of before you decide to call your lender and get the process started.
One of the biggest causes of concern for most borrowers is whether refinancing their mortgage will save them money over the life of their loan or end up costing them. Whether you’re purchasing a home or refinancing your existing mortgage, you’ll be required to pay closing costs covering all the expenses of closing and compensating those who make the transaction successful.
Closing costs are typically anywhere from 3-6% of the loan amount, so you’ll need to calculate your break-even point on how much you need to save each month to cover the closing costs.
For example, a borrower who pays $5,000 in closing costs needs to save at least $5,000 over the life of their loan to break even and make the refinance worth the cost.
However, most people don’t stay in their homes for the life of the loan, so a refinance may not be worth it for many people. Especially if they plan on moving before they reach the breaking-even point. If you’re refinancing to avoid a foreclosure or short sale, make sure you crunch the numbers carefully to make sure it’s worth it.
Another thing to consider is the unintended trade-off from your refinancing. For example, you can lower your monthly payments, but it could add several years to your mortgage. You’ll essentially be restarting your mortgage and likely committing to another 20 or even 30 years of payments.
Ready To Learn More?
Refinancing can be an excellent opportunity to save money on your mortgage, reduce your loan term, or eliminate mortgage insurance from your current loan. However, it’s important to consider the drawbacks of refinancing to decide if it’s worth it in your situation.
If you’re curious about whether it’s a good time to refinance, the experts at Leading Edge Title can help.
Our title agency is made up of a team of qualified experts who are ready to advise you on the entire process and make refinancing your home easy.
Visit our website to find out why Leading Edge Title is the go-to title agency for real estate closing services in Central Florida.