For some homeowners, refinancing is a convenient and potentially money-savvy way to improve their financial situation, take advantage of the equity they’ve earned, or make much-needed repairs to their homes.1 But refinancing your mortgage is a big decision and one you should carefully consider before you begin.
Whether refinancing your mortgage will be advantageous depends on the age of your loan, the value of your house, and other factors. Before you start the refinancing process, it’s important to know how your situation fits into the equation.
So, what are the pros and cons of refinancing? To know if it’s a worthwhile endeavor, it helps to understand whether refinancing will save you money or drain your checking account. Then, you can seek out other options if your current loan isn’t working, but refinancing isn’t in the cards.
Why Do People Refinance Their Mortgage?
When you refinance your mortgage, you’re essentially taking out a new loan on your home to replace the original.1 Just like with your existing loan, you’ll go through all the steps of finding a lender, applying for approval, and securing the funds.
However, except in some cases, you won’t receive the bulk of the loan money. Instead, your new lender will use the funds to pay off your original mortgage.
Refinancing a mortgage is common practice. In 2020, 8.4 million homeowners ditched their old loans in favor of new ones—an increase of nearly 150% over the previous year.2
But what makes refinancing so popular?
There are many reasons that someone might choose to refinance their mortgage. Typically, financial concerns top the list, as refinancing is often an opportunity to get out from under costly home loan conditions like:
- High interest rates
- High monthly payments
- Mortgage insurance
Frequently, homeowners refinance because they’re unhappy with other aspects of their loan, like the loan term or whether total interest is accrued at an adjustable or fixed rate. In other cases, people refinance homes to pay off debt, or to make big-budget home repairs.
The Pros of Refinancing Your Mortgage
The pros and cons of refinancing mortgage loans are important to know before you decide whether it’s the right option for you. Depending on the age of your current loan, the value of your house, and your general financial situation, refinancing can help you improve your finances and achieve certain financial goals.
When you refinance, you may have the opportunity to negotiate for:1
- Lower interest rates – Mortgage refinancing is often an opportunity for homeowners who are unhappy with their interest rates to find a better deal. Mortgage interest rates are in a near-constant state of flux.3 They can change by the day or even by the hour, so if you took out your original loan when interest rates were high, refinancing when rates are low could save money.
- Lower monthly payments – Are you struggling to meet your mortgage loan payment every month? Refinancing could be your chance to secure a lower monthly fee if you’re able to drop your mortgage insurance, secure a lower interest rate, or extend the life of your loan.4
- A shorter loan term – In some cases, homeowners choose to refinance because they want a quicker path to full home ownership.5 For example, if your original loan has a repayment period of 30 years, refinancing is your opportunity to switch to a 15 or 20-year repayment plan. If you wish to sell your home in the future, you may wonder if you should refinance before selling. A shorter loan term means you can put your home on the market faster, so it might not be a bad idea.
- No more mortgage insurance – Another pro of refinancing your mortgage is that it could be your chance to stop paying mortgage insurance. If you put less than 20% down on your original loan, there’s a substantial chance you’re paying mortgage insurance fees in addition to your monthly payment.6 But if you’ve built up enough equity, you won’t have to pay insurance on your new loan, which could save money every month.
Lastly, if you need extra cash, refinancing your mortgage may be a quick way to access more money. When you refinance, you’ll have the opportunity to convert the equity you’ve earned on your home to cash.5 That’s money that people frequently use to make home repairs, pay for college, or pay off other debt.
The Cons of Refinancing Your Mortgage
The pros and cons of refinancing include a few drawbacks that give pause to some homeowners. Although refinancing can be a boon, taking out a new loan is a lengthy process that could be more trouble than it’s worth.
When it comes to the potential downsides of refinancing mortgage loans, here’s what you should know:5
- You’ll have to pay closing costs – Just like with your original loan, your refinanced mortgage is going to come with closing costs in addition to the principle. These costs can include things like a home appraisal for refinance fees, title insurance, origination fees, and so on.
- Your monthly payments could be higher – Although some people refinance their mortgage to secure a lower monthly payment, refinancing could have the opposite effect. Depending on your new interest rates and whether you shorten or extend the length of your loan, your monthly payments could increase after refinancing.
- Your overall loan amount could be higher – Another potential con of refinancing your mortgage is that it could raise the principal amount of your loan. Even if your new loan offers lower interest payments, if you choose to extend the life of your loan, you can expect that interest to add up.
- You’ll have to qualify for a new mortgage – Refinancing means starting the loan application process from scratch. Aside from verifying your income and employment, you’ll also have to have your home inspected and appraised. Depending on your loan broker, you may also need to have already accumulated at least 20% of the home’s value in equity.
When it comes to the pros and cons of refinancing mortgage loans, it’s important to keep in mind that timing can play a significant role. Fluctuating interest rates and fickle markets can drastically affect whether refinancing is worth it, so be sure to do the necessary research before you commit.
It’s also worth weighing the pros against the cons. For example, if you’re struggling to meet your mortgage payment, refinancing may be worth it if you can switch to a lower monthly payment, even if that means you have slightly higher interest rates or a longer loan term.5
Alternatives to Refinancing Your Mortgage
Due to the various factors that can affect the pros and cons of refinancing, it may not be the best choice for everyone. For example, if you can’t secure better interest rates or lower monthly payments, it might be wiser to find another option.
Fortunately, if you’re unhappy with your current home loan, but refinancing doesn’t seem like the best route to take, you still have options. There are other ways homeowners can shrug off debilitating mortgages and take control of their finances.
You can also learn how to get equity out of your home without refinancing. Instead of refinancing, many homeowners choose to:5
- Secure a home equity loan – Home equity loans are available for up to 85% of your home equity. As an alternative to refinancing, they provide access to a lump sum that can be used to pay off debt or make repairs. Often, you can establish repayment plans for up to 30 years on home equity loans.
- Secure a home equity line of credit – Unlike a home equity loan, a home equity line of credit allows you to borrow against your equity multiple times. Homeowners who choose this route may be drawn in by the chance to have lower monthly payments, interest-only payments, and leniency when it comes to making withdrawals.
- Use a residential sale-leaseback – In some cases, the best option may be to sell your home to an outside investor, business, or individual and then lease it back from them. This gives you time to work on your finances and convert your equity to cash without losing your home or falling behind on payments.
If you’ve looked into refinancing your home and have decided to go in a different direction, the best next step is to speak with a financial advisor. Together, you can assess your finances, review your options, and find the plan that works for you.
Your home may be the most valuable asset you ever own. But when you’re struggling under the weight of costly monthly payments, sky-high interest rates, or less-than-desirable loan conditions, your house can seem more like a hassle than a haven.
When that happens, you need a solution that eases your financial stress without sacrificing everything you’ve worked so hard for. Sale-leaseback programs are the refinancing alternative that allow you to get out of your current mortgage, convert your home equity to cash, and stay in your home.
- Investopedia. When to Refinance Your Mortgage. https://www.investopedia.com/mortgage/refinance/when-and-when-not-to-refinance-mortgage/
- Consumer Finance. Mortgage refinance loans drove an increase in closed-end originations in 2020, new CFPB report finds. d-originations-in-2020-new-cfpb-report-finds/#https://www.consumerfinance.gov/about-us/newsroom/mortgage-refinance-loans-drove-an-increase-in-closed-en
- The Truth About Mortgage. Do Mortgage Rates Change Daily? https://www.thetruthaboutmortgage.com/do-mortgage-rates-change-daily/
- Nerd Wallet. How to Lower Your Monthly Mortgage Payment. https://www.nerdwallet.com/article/mortgages/how-to-lower-your-monthly-mortgage-payment
- CNBC. The pros and cons of refinancing your home. https://www.cnbc.com/select/pros-and-cons-of-refinancing-home/
- The Mortgage Reports. How much is mortgage insurance? PMI cost vs. benefit. https://themortgagereports.com/24154/private-mortgage-insurance-pmi-cost-low-downpayment-return-on-investment