Refinancing is a word that has probably caught your eye if you’re a homeowner or have taken out a loan to buy a home. But what is refinancing all about?
Refinancing is when you take out a new loan to repay an existing loan; in this case, it’s your mortgage. The purpose of refinancing is to secure better loan terms, such as a lower interest rate, a shorter loan term, or lower monthly payments. It’s a financial strategy that provides substantial benefits, but it also has its drawbacks. It’s worth exploring, but it’s important to weigh its pros and cons before deciding.
Let’s examine the pros and cons of refinancing and cover some important factors to consider before obtaining one.
Pros of Refinancing
Refinancing can potentially bring a host of benefits to your financial situation. Some of the most notable advantages of refinancing a property are:
Lower Interest Rates and Monthly Payments
Refinancing could help you secure a lower rate and save money in the long run if the interest rates have dropped since you took out your original loan. Lower interest rates mean you’ll pay less in interest over the life of your loan, which can significantly add to your savings.
Shorter Loan Terms
A shorter loan term is one of many benefits of a refinance, especially if you want to repay your loan faster. Your monthly payments may be higher, but you’ll pay less interest and repay your loan faster.
Add or Remove a Co-borrower or Cosigner
Refinancing allows you to remove an individual you applied the mortgage with or add a new co-borrower with a strong credit and income history who may help secure better rates and terms.
Get Rid of Private Mortgage Insurance (PMI)
Conventional home loans and down payments of less than 20% of the home’s value may require you to pay for private mortgage insurance (PMI) to protect the lender from potential default. However, PMIs can significantly raise your monthly mortgage expenses.
Increasing your home’s value and paying off a portion of your loan may give you the required 20% equity to avoid paying for a PMI. By refinancing to a new loan with the updated home value calculation, you can now say goodbye to PMI, potentially saving you between 0.2%, 2%, or more of your loan balance annually.
Cons of Refinancing
While refinancing can improve your financial situation, it’s not without drawbacks. Here are some of the most significant disadvantages of refinancing to consider:
Refinancing involves taking out a new loan, which means paying closing costs, including appraisal fees, loan origination fees, and title insurance, among others. These costs can be substantial depending on your loan’s size, so keep this in mind when making a decision.
Longer Loan Terms
While refinancing can help reduce your monthly payments, it may also extend your loan’s term. However, this may be counterintuitive if you want to pay off your debt faster.
Negative Impact on Credit Scores
When you apply for a mortgage refinance, lenders will often conduct a hard credit inquiry to evaluate your credit report and determine your eligibility for the loan. The hard inquiry will remain on your credit report for two years and may lead to a temporary dip in your credit score for several months. Your prior mortgage will appear as a closed account on your credit report when you refinance, which may also negatively affect your score.
When refinancing, hard inquiries or account closures are unavoidable. But, making timely payments towards your new loan will likely improve your credit score. Knowing the potential impact of your credit score is important if you plan to apply for other types of credit soon.
Potential Loss of Equity
You should keep in mind that you may reduce the equity in your home if you opt for a cash-out refinance. You’ll be taking on more debt that could have long-term implications if your home’s value doesn’t increase or you experience financial difficulties.
Potential for Hidden Fees
When refinancing your mortgage, be mindful of hidden fees buried in the fine print. Lenders may charge fees for services like underwriting, loan processing, or document preparation, so always read the terms of your loan carefully and ask questions if you’re unsure.
Is refinancing right for you?
You may be in a good position to refinance your home if:
1. You can save money.
Savings are the top pros of refinancing many consider. Refinancing may be worth your while if your new computed interest rate is at least 0.5% lower, and you can save enough each month over time to recoup the closing costs within a reasonable period.
2. You have a good credit score.
In a market with rising interest rates, having a credit score of 670 or higher on the FICO scale can help you secure the lowest possible rate and maximum savings. An improvement in your credit score since first obtaining your mortgage is an excellent reason to consider refinancing.
3. Changing your loan’s attributes helps improve your financial situation.
Refinancing is viable if you want to switch to a fixed interest rate, add or remove a co-borrower, or eliminate private mortgage insurance. However, refinancing to a longer loan term may not result in significant savings. But if you can afford a shorter term, refinancing can help you save on interest and repay your mortgage faster.
On the other hand, refinancing may not be for you if:
1. The potential interest savings are minimal.
The cons of refinancing may not let you have significant savings. Refinancing may not be worth it if you can’t afford a shorter repayment term or the interest rate you qualify for isn’t much lower than what you currently have. You must consider the closing costs and how long it will take to recoup them through your savings.
2. You’re struggling to make monthly payments.
Refinancing into a lower monthly payment may not provide a long-term solution if you face financial difficulties. Instead, you may want to contact your loan servicer to explore a mortgage modification.
3. You’re not yet eligible for refinancing.
Depending on your mortgage type, there may be restrictions on how soon you can refinance. For example, you may need to wait at least one to two years if you have a loan with hardship modifications like a longer term or lower monthly payment.
Refinancing is a double-edged sword. Depending on your situation, it can help reduce your monthly payments, remove a co-borrower or private mortgage insurance, and shorten your loan term. But, it can also negatively impact your credit score and result in a potential loss of equity, longer loan terms, and additional costs.
Ultimately, deciding on refinancing your mortgage will depend on your needs. The most crucial step you need to take is to determine the loan options available to you and understand what they entail.
Check your refinancing options today.
Sometimes, just knowing the pros and cons of refinancing isn’t enough; you may need to consult experts like Cedar Home Loans. We have local expertise, knowledge, and years of experience that allow us to offer the most flexible mortgage and refinance rates in Colorado.
Your dream home is within your reach. Reach out to Cedar Home Loans today.