Like most Americans, your home may be the most expensive investment, and you probably took a mortgage to make this purchase possible.
There are many compelling reasons to consider refinancing your home, including lower interest rates. If you follow business news, you’re probably aware of mortgage rates being on the decline and wondering if that makes now a good time to refinance.
However, depending on your unique circumstances, refinancing might not be the best option at your disposal. It could affect your credit score, equity, and finances in a negative way.
Are you on the fence about whether to refinance your home? Why do you refinance a house?
Before talking to a loan officer, how about taking the time to understand the true pros and cons of refinancing your home? Doing this will let you see the bigger picture and develop a strategy to realize the best possible outcome for you. You can even learn how to save without refinancing.
Why Do You Refinance a House?
Put simply, home refinancing means taking another loan on a house you still owe on the mortgage. It’s basically a loan with a new principal and a different interest rate, payment schedule, or other terms stipulated in the contract.If you’re a qualified homeowner, you can use the new loan to settle your old loan and secure lower interest rates that will lead to more affordable monthly payments.
Even half a percentage point can make a notable difference over the life of your loan. Your new loan will be based on your home’s current value.
Refinancing your home can also let you tap into your equity to access money without selling your home. Life happens, and you could find yourself in an emergency that requires a significant amount of money. There are generally no restrictions on how you can use the money from a cash-out refinance. This could be a medical emergency or a job loss.
Benefits of Refinancing Home
There are several benefits to refinancing your mortgage.While most revolve around reducing your monthly payment, refinancing your home can shorten your mortgage length, help you tap into home equity, etc.
Lower Your Monthly Commitment Through Lower Interest
If the prevailing interest rates are lower than your current rate, you could save money through refinancing. For instance, refinancing a $500,000 mortgage to lower the interest rate from 6.0 percent to 3.0 percent could save you over $800 monthly.
Shorten Your Mortgage Term
With a new loan comes a new amount of time to pay off your debt. A shorter mortgage length can help you get the most from your home if you’re considering selling your home in the near future. Going from a 30-year to a 15-year mortgage will help you build equity faster.
Roll Over From an Adjustable to a Fixed-Rate Mortgage
Adjustable-rate mortgages are known to be great for the initial term of three to five years, but once that time is over, the monthly payment can spike. Refinancing this type of mortgage can give you a fixed and predictable rate that will give you more breathing room in your budget. And If you put less than 20 percent down when you purchased your home, refinancing can help you ditch private mortgage insurance.
Switch to a Different Bank
If you don’t agree with the policies of your current lender, refinancing can let you switch to a different bank. Refinancing can also help you take your name out of a joint home loan.
Cash Out Your Home Equity
If you need a lump-sum amount of money to cover a pressing financial need, such as a big medical bill, pay off high-interest debt, or remodel your home, another pro of refinancing is the opportunity to cash out the value appreciation of your property.
Cons of Refinancing Mortgage
Despite all the benefits we’ve discussed, you’ll also want to consider the potential downsides of refinancing your home.
Before you consider refinancing your home, check your circumstances to avoid ending up in more financial struggles.
These are the most common reasons homeowners decide
not to refinance:
Potential Pre-Repayment Penalty
Some home loans have lock-in periods, meaning you’ll pay a penalty if you decide to pay off your principal balance earlier than what’s stipulated. Ensure you understand the terms and conditions before closing on your new loan.
Getting a lower interest rate often requires paying “points” toward your mortgage. To lock in your loan, you may need to pay cash out of your pocket. You’ll be responsible for refinancing costs for your new loan, and while it’s possible to roll closing costs and fees for stuff like home inspections into the new loan, doing so will increase your monthly payment and could erode your savings.
Taking out a new loan closes out your original mortgage and decreases the overall age of your credit accounts, causing your credit score to dip. The financial institution will also perform a hard credit inquiry, which has a small but negative impact on your score. A hard credit inquiry remains on your credit report for up to two years.
By stretching the life of your loan by five or 10 years, this could push your breakeven point further into the future. A refinance calculator can help you approximate your total savings and when you can actualize them.
If you take out too much money, you risk going underwater—that is, having a mortgage that is higher than your home’s value. To avoid this trap, it’s vital to understand the actual market value of your home before signing loan documents.
When Should You Refinance Your Home and When to Avoid
Timing is key in refinancing, and it’s best to refinance when conditions work in your favor.
Refinancing your home is a good idea when:
- You qualify for a lower interest rate.
- Your credit profile has improved.
- You want to unlock the equity that you’ve built into your home.
- Your interest savings exceed the closing costs.
- Your breakeven point is decades away.
Refinancing your home is
not a good idea when:
- Current interest rates are high.
- Your credit score has dipped.
- You can’t afford your new loan payments.
How to Save Without Refinancing
If you’re happy with your current mortgage rate and term, but you still need to access your home equity, consider:
- a home equity loan;
- a home equity line of credit; or
- a personal loan.
Summary
Unlike long ago, when it seemed like homeowners were stuck with one bank for their entire loan term, it is now common for people to refinance their homes.
Whether you’re considering a home equity loan, a mortgage refinance, or a cash-out refinance, you should thoroughly evaluate the pros and cons of refinancing your home. Ultimately, refinancing should be a financial decision that works in your favor—not against it.
Remember, while refinancing your home can be a helpful tool for managing your finances, it’s in no way a one-size-fits-all solution. It’s critical to perform diligent research, consider all angles, and consult a trusted financial advisor before you dip a toe.
Hopefully, this article has answered your question of “why do you refinance a house” and given you some tips on how to save without refinancing.
The Epoch Times copyright © 2023. The views and opinions expressed are those of the authors. They are meant for general informational purposes only and should not be construed or interpreted as a recommendation or solicitation. The Epoch Times does not provide investment, tax, legal, financial planning, estate planning, or any other personal finance advice. The Epoch Times holds no liability for the accuracy or timeliness of the information provided.
