Refinancing is a big financial decision—it can save you thousands of dollars on your mortgage during the lifetime of your loan. That puts more money in your pocket to spend on things like repairs and renovations, paying off other debt, or however you see fit.
But it’s not always a wise move to refinance whenever you see interest rates are low. There are a lot of different considerations to take into account to figure out if refinancing is right for you.
To help, our team has put together this guide to the pros and cons of refinancing. With this guide, we hope you can make an informed decision that’ll benefit your home—and your bank account.
What is refinancing?
Refinancing is the process of taking out a new mortgage loan to pay off and replace your original one. Many homeowners refinance their homes when they want to lower their interest rates (and save money on interest over time).
Mortgage rates are constantly fluctuating as the housing market changes. If you bought your home during a poor market environment, but the market is now more suited to you, there’s a chance you could lower your interest rate by refinancing.
What are the different types of refinancing?
There are two main refinancing options: rate-and-term and cash-out. Let’s discuss these and their pros and cons.
The most common mortgage refinance option is rate-and-term. This type is typically what people mean when they say “refinancing” in general.
A standard rate-and-term involves replacing your current mortgage agreement with one that has, well, a more favorable rate or term.
You can use a rate-and-term to reduce your interest rate and either pay more per month or pay less per month, but extend the length of your loan. Which one you choose will depend on your individual financial situation. Some homeowners don’t mind paying more per month if it’ll save them in the long-term, but some find that paying less per month lets them build up their savings in a way they couldn’t afford to before.
Cash-out refinancing lets you reduce your interest rate while also borrowing extra money against the equity of your home.
When you pay off your mortgage, you build up home equity. You can then take back some of that equity to pay off debts, make home improvements or renovations, or add a bit of cash to your bank account. Many homeowners opt for cash-out refinances when they want to use their home equity while also avoiding high-interest credit cards.
While this option may seem ideal, it’s important to know that it often requires a variety of application, appraisal, and other fees that can offset some of the savings you may make. It’s also only suited for homeowners who have built up considerable equity in their homes.
The Benefits of Refinancing
- Save in the long-term. By reducing your interest rate, you can save money over the lifetime of your loan.
- Reduce your monthly payments. If you’re struggling to build up savings or make your monthly payments, refinancing could help reduce what comes out of your pocket every month.
- Stabilize your interest rate. If you have an ARM, your future interest rate could increase and lead to a higher monthly payment. Changing to a fixed-rate term will stabilize your interest rate and monthly payments, making it easier to manage your debt.
- Pay off your home quicker. If refinancing terms shorten your loan time, for example, changing from a 30-year loan to a 15-year loan, you could pay off and own your home quicker. In the long run, you will be saving money on interest payments.
When is it a good idea to refinance?
Knowing when it’s worth it to refinance can be tricky. It often involves sitting down with a calculator and pencil and doing some math to work out if the fees involved amount to less than what you’d save over time from lowering your interest rate.
Here are some indicators that the pros outweigh the cons:
If It Saves You Money
If your calculations tell you that you’ll save money, build up equity, and pay off your mortgage quicker, then it’s likely a good idea. To ask about things like application and appraisal fees, call a lender directly for quotes—and don’t forget to shop around.
If Your Interest Rate Will Reduce
If your interest rate can lower by one-half to three-quarters, it will also substantially lower your monthly mortgage payments. Remember, even if you can drop your rate drastically, it has to be more than what you’d spend on up-front fees.
If It Helps You Build Up Savings
If you find that every paycheck disappears before you can put a part of it away into savings, it’s time to sit down with your monthly finances and determine where your money is going.
If you’re not sure it’s not being spent on an expense that you could potentially cut down on, then one way to get more money each paycheck is to lower your monthly mortgage payment through refinancing.
When is it NOT a good idea to refinance?
Even if the market is in your favor and you know it’ll save you money, refinancing may not be the best option for you depending on certain factors, such as:
If You Switch from a Fixed Rate to an Adjustable Rate
Adjustable rates can start lower than fixed ones. While refinancing to an ARM can offer you short-term savings, because of the fluctuating market and economy, you could end up paying more in the long term.
Staying with a fixed-term rate means you will make the same repayments each month without ever having to worry about potential increases in the market.
If Your Loan Term Extends
If you’re planning on staying in your home long-term, extending your loan term can seem like a good idea. Stretching the remaining payments will reduce your monthly bill. However, in the long term, you could end up paying more, as you will be making mortgage repayments for longer.
If You Plan on Moving
If you plan on moving out within two years of refinancing, you won’t have much time to recoup the cost. Therefore, you could end up losing money.
Want to refinance? Let us help
Whether you’re planning on refinancing your home or just want more information to help make the decision that’s right for you, get in touch with our team of experts here at Associates Home Loan.
Every homeowner is different—but our goal is to help guide you through the pros and cons of refinancing to ensure you have everything you need when deciding.