Refinancing is the process of replacing your current mortgage loan with a new loan that carries a new set of terms. For homeowners, refinancing can be an opportunity to secure a lower interest rate or even take cash out.
If you plan to sell your current home and buy a new property, you might wonder if refinancing is a good way to access your home equity and secure a down payment.
In most cases, it doesn’t make sense to refinance shortly before selling. Today, we’ll discuss some reasons why a homeowner might consider refinancing before selling and other home equity loan alternative options.
Should I Refinance My Home if I Plan to Sell?
As mentioned, the answer to this question is contingent on your financial situation and future plans. The first thing you have to consider is when you plan on selling the home.
If you have a vague plan to sell five to ten years down the road, then a refinance may be the smart decision. But if you want to sell your home within the next year, it’s likely not worth the effort. You may even have trouble finding a lender willing to agree to the refinance if they know you plan on selling soon.
For people who plan to sell a home in the distance future, refinancing carries the following potential benefits:
- Enjoy a lower interest rate – If interest rates are lower than when you originally bought the home, a refinance would give you a lower monthly payment and save you money in the long term. Or, if your credit score has improved over time, you may be able to qualify for a lower interest rate than before.
- Lengthen or shorten the mortgage term – A refinance resets the clock on loan payments. Opt for a shorter term to get out of debt sooner or extend the loan’s duration to get a lower monthly payment. If you simply want a lower monthly payment, learn how to lower mortgage payments without refinancing.
- Take cash out of equity – If you have built up equity, a cash out refinance loan lets you take a higher principal balance in exchange for cash. Taking this action enables many homeowners to consolidate high-interest debts such as credit cards or personal loans.
- Eliminate mortgage insurance – Homeowners, especially those that obtain government backed loans like a Federal Housing Administration (FHA) loan, also have to pay private mortgage insurance (PMI). However, after the homeowner has accrued 20% equity, a conventional mortgage refinance would eliminate the PMI payments.
However, keep in mind that whether you’re eligible for these benefits depends on your credit history, income, and equity. It can be hard to refinance with bad credit, so you’ll need to consider these factors first.
In addition, refinancing is not free. Remember all the closing costs you paid when you bought your home? There are similar costs associated with refinancing.
Can You Refinance Then Sell Your Home?
Legally speaking, there’s nothing stopping you from refinancing your home then selling. But just because you can doesn’t mean you should.
Refinances aren’t free. They can cost thousands, if not tens of thousands of dollars—the normal range is 2% to 6% of the loan amount. So, you have to run a cost benefit calculation as to whether the savings earned via the refinance will outweigh the closing costs, such as:
- Application fee – Often, this is a non-refundable fee that must be paid even if the lender rejects the application.
- Appraisal fee – The lender will need to get an accurate estimate of the home’s current value to loan the right amount. According to Home Advisor, the average single-family home appraisal cost averages between $312–$419.
- Origination fee – This is the fee charged by the lender in exchange for processing and underwriting the loan. This ranges from .5% to 1.5% of the loan amount.
- Inspection fee – Some states require that the house undergo an additional inspection before the refinance closes.
- Title search and insurance fee – Homeowners need to pay for a new title search to ensure that the home is free of any pre-existing liens on the house. Similarly, you may also be required to pay for title insurance.
The only way a refinance will make financial sense is if the time frame to sell is far enough away that you will eventually recoup the closing costs.
For example, if you’re refinancing a $300,000 loan, you can expect closing costs in the neighborhood of 3%—approximately $9,000 for the refinance. While this may give you the cash you need for a down payment on a new home, that access comes at a very high price.
Prepayment Penalties to Consider
What if you’re able to sell the home at a profit and pay off your refinanced mortgage immediately?
You need to examine your documents and ensure that it doesn’t have a prepayment penalty. If it does, even if you sell the home and pay off the loan, you’ll still need to pay extra. According to Forbes, prepayment penalties will typically start at approximately 2% of the outstanding balance.
Why Refinance When You Have a Sale-Leaseback?
If you need cash, want to consolidate debts, or hope to do a cash out refinance to buy a second home, you might feel like your only options are to refinance or sell.
In most cases, the costs to refinance before selling will outweigh the potential benefits. But selling your home can also feel like a risky prospect if you’re unsure where or when you want to move.
So, what then?
A sale-leaseback is the alternative solution to home equity loans and refinancing. These innovative solutions help you convert your home’s equity into cash while staying put in your current home for as long as you need or want.
If you’re looking to sell your home and buy a new property, refinancing might be helpful for you. For homeowners, refinancing can be an opportunity to secure a lower interest rate or even take cash out. If you are still unsure of options to securing cash when purchasing a new home, after reading this article, consult a financial advisor to discuss your options.
- FHA. FHA Cash-Out Refinance Mortgages. https://www.fha.com/fha_refinance
- Home Advisor. Home Appraisal Cost. https://www.homeadvisor.com/cost/inspectors-and-appraisers/hire-a-property-appraiser/
- Forbes. Prepayment Penalty: What It Is And How To Avoid One. https://www.forbes.com/advisor/mortgages/prepayment-penalty-what-it-is-and-how-to-avoid-one/