Refinancing Your Mortgage, Benefits & Downsides

If you’re a homeowner with a mortgage, you may have heard of the advantages of refinancing. The benefits are far-ranging and include the chance to reduce your interest rate, lower your monthly payments, and the ability to tap into your equity. There’s also no limit to the number of times you can refinance. Theoretically, you could refinance immediately after closing on your loan. But like all things, there is a catch. Just because you can refinance your loan doesn’t mean you should.

Here’s a look at everything you need to know about refinancing and how you can get the most out of your loan.

What are the Benefits of Refinancing a Mortgage?

Most people choose to refinance for one or more of the following reasons.

• A Better Interest Rate – This is the most common. A lower interest rate can lead to significant savings over a long-term loan. You stand a good chance of getting a better rate if your credit score has improved since you took out the loan or if rates, in general, have fallen since then.
• Lower Monthly Payments – A lower interest rate means a lower monthly payment. Advantageous if your refinanced loan has the same payoff date as your previous loan.
• More Predictable Costs – If your first loan was an ARM (adjustable-rate mortgage), you might want to refinance a fixed-rate loan for more predictable monthly payments. This might mean taking on a higher interest rate, but at least you’ll be comfortable knowing it won’t go any higher.
• Shorten Your Loan Term – A common tactic for borrowers with a 30-year mortgage is to wait a few years and refinance to a 15-year loan. Doing so can allow you to repay your loan faster and save more interest over the loan’s lifetime.
• Borrow Money – Through cash-out refinancing, you can borrow against your equity to access funds for any purpose. They will add the amount you borrow to your mortgage principal. This can be a great way to raise money for an emergency.
• Cancel Mortgage Insurance – If your original loan came with PMI, you’d be able to refinance once you reach 20% equity. It also applies to certain FHA loans with PMI for the loan’s lifetime.

What are the Downsides of Refinancing?

While there usually isn’t any limit on the number of times you can refinance a loan, you’ll unlikely do it too often as it will mean paying closing costs each time. This can add up to 2-7% of the home’s value. This can add up to a hefty amount in a costly market like NYC. This is why it’s essential to do the math first. Work out your breakeven point and whether you stand to save more in the long run once these closing costs have been offset.

Another negative impact of multiple refinancings is that they will lower your credit score. A loan officer must perform a hard credit check each time you refinance. Since credit checks remain on your report for up to two years, too many can leave a lasting mark in a short time. Make sure you have a solid enough credit score to take a minor hit when contemplating multiple refinancing in 24 months.

Lastly, you need to consider how many extra years you’ll be adding to the loan by refinancing? If your interest rate is lower, you could still pay more by adding another five years to a 30-year fixed-rate loan. One solution might be refinance with a 10, 15, or 20 years short-term loan. This might mean taking on a higher monthly payment and a lower interest rate that can add to significant savings in the long run.

When Is It a Good Time to Refinance?

The last few years saw interest rates fall to record lows. However, they’re now on the rise again. According to Freddie Mac, as of this writing (28 May 2021), a 30-year fixed-rate mortgage sits at 2.95%. Knowing whether you should wait to see if they drop again or refinance before they spiral even higher can be challenging. This is a personal question that each homeowner will have to wrestle with. As a rule of thumb, refinance is probably a good idea if the numbers look reasonable.

What it comes down to is how much you stand to save. If interest rates have dropped enough, they could reduce your monthly mortgage payments by $50-100, an excellent reason to refinance. For a 30-year conventional loan, savings like that can add up.

Should You Refinance with Your Current Lender or find a New One?

If your primary goal is to get a lower interest rate, that may not be easy if you stick with your current lender. Getting a good deal helps you shop around and see what other lenders offer. When comparing lenders, don’t just focus on the varying interest rates. Look at the costs of acquiring the loan, including loan fees, repayment terms, and the different loan packages.

Even if you choose to refinance with your current lender, researching what else is out there can help you negotiate for a lower interest rate. Mention a competing lender’s better rate, and your current lender may try to match or beat it to keep your business. If you go with your current lender, read the fine print to understand if the new loan comes with points. These are prepaid fees that are used to get a lower interest rate. One mortgage point typically equals 1% of the loan amount and can reduce your interest rate by 0.25%.

The best way to compare different lenders is to get multiple loan estimates. Each estimate will lay out all the costs of acquiring the loan to be easily compared. Keep in mind that switching lenders will mean more hassle and paperwork.

Final Thoughts

Any decision to refinance your mortgage should be a well-thought-out one. Refinancing has many risks, pitfalls, and benefits for those who time it right. Even if all the experts agree that now is a good time, it depends mainly on your financial situation and long-term goals. For personalized advice, please talk with a financial planner and get their assessment on whether it’s a good idea.