Mortgage interest rates have been hovering around an all-time low for a while now and
naturally when this happens, a common question I get is, “Is it a good time for me to
refinance?”

It’s a wonderful question to ask and means you’re thinking about the bigger picture.

Refinancing your mortgage could potentially save you thousands of dollars.

However, it isn’t always a simple process and it’s not for everyone.

Here are a few pros and cons to refinancing your mortgage to consider so that you can
make the best decision possible for your family.

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What is Refinancing?

When you refinance the loan on your home, you are actually taking out a brand new
mortgage. I mean, think about what the prefix “re” basically means again, so you’re
essentially financing the property again.

You decide that you would like to improve the terms on your existing mortgage. So, you
do your research and find a lender that’s willing to offer you better terms than your
current lender.

Then you apply for a new mortgage loan with better terms. If you’re approved, your new
lender pays off the remaining balance to your old lender.

You then start making payments to the new lender under the agreed upon terms until
that loan is paid off or you choose to refinance the second loan.

Refinancing does not lower the total balance that you owe on your mortgage. As a
matter of fact, your loan balance could go up with certain types of refinancing.

If refinancing doesn’t lower the mortgage balance, then why would you do it?

Well, some people find themselves in a tough financial spot and may refinance to get a lower monthly payment.

Other people may realize that they took out an awful mortgage loan and refinance to get under better terms.

There are many personal reasons why someone may refinance their mortgage, but just because there are benefits doesn't mean there aren't flaws as well. Click To Tweet

 

Pros Of Refinancing Your Mortgage

Shorten Your Mortgage Term

Shortening your mortgage term from 30 years down to 15 years could raise your monthly payment, but it could save you thousands of dollars in interest. 

For example, let’s say you’re approved for a $200,000 mortgage at 6% interest with a 30 year mortgage.

You’d pay over $231,000 in just interest. Yes, that is $30,000 more than the actual mortgage you took out when you added interest. 

By going for a 15 year mortgage on the same two-hundred thousand dollar loan at the same 6% interest rate, you’d be paying about $103,000.

This is almost $130,000 in savings and that could go towards wealth building investments like retirement accounts, saving for your kid’s college or whatever aligns with your life financial goals.

Again, it’s likely that your monthly payment is higher, but in the long-term you could save hundreds of thousands of dollars by refinancing into a shorter term.

Not to mention you could be eliminating that monthly payment even faster.

Lower Interest Rate

There are two things that can help you qualify for a lower interest rate:

1. Market conditions

2. An improved credit score

Let me give you a real example of just how much you can save by refinancing with a better interest rate. 

You take out that $200,000 mortgage with the 30 year term and the 6% interest. At the end of the 30 years, you have paid over $231,000 in interest.

Let’s say you refinance at year two. At year 2, your remaining loan balance would be around $195,000 and you’d still be on the hook for about $207,000 in interest. 

Somehow you learn that you can get a 4.5% interest rate instead of the 6% that you’ve been paying for two years.

You decide to refinance that remaining $195,000 balance with another 30 year term.

At the end of that 30 year term, you will have only paid $160,455 in interest. 

Had you not refinanced, you would have paid $207,000 in interest from years two to year 30 but with the refinance you save over $46,000 in those years. 

You could also find yourself needing a lower interest rate if you have an adjustable rate mortgage.

An adjustable rate mortgage or ‘ARM’ as people call them will usually have a lower interest rate in the early days of your loan, but after a set amount of time, you could find your rate changing.

Sometimes this leads to a higher interest rate and monthly mortgage payment. 

Refinancing to a fixed rate mortgage not only gives you a consistent payment over time, but it could also bring that interest rate and that monthly payment back down.

Get Rid of PMI or MIP

If you don’t put enough money down when you’re purchasing your home, you may have to pay what’s called Private Mortgage Insurance or “PMI.” 

If you have an FHA loan, you might have what’s called Mortgage Insurance Premium or “MIP.” 

Both of these can cost you about 1% of the loan on an annual basis, which means that not putting enough down on a $200,000 house could get you an additional payment of about $166 a month. 

That payment stands until you’ve paid off about 20% of your loan value or you’ve owned your home for a certain length of time. 

It depends on if you choose a conventional or FHA refinancing program to get rid of PMI or MIP, either way this is a smart money move. 

If you have an FHA loan, you can consider refinancing to a conventional loan to remove the MIP. 

Once you hit a 78% loan-to-value ratio, your lenders will automatically remove PMI on a conventional loan if you don’t reach out to them yourself once you’ve hit that 80% mark

You can build enough equity to remove PMI by paying off your mortgage really fast or by the value of your home rising. 

All this to say, make sure you’re checking this periodically.

Just by being vigilant, you could save $166 a month on a $200,000 home. 

Cons Of Refinancing Your Mortgage

In some cases, refinancing your mortgage is not a good idea.  

Closing Costs And Fees

There are costs associated with refinancing, it’s not a free process.

Refinancing a mortgage could cost you anywhere from 3-6% of the total loan balance.

It’s a lot of the same fees that you were responsible for when you took out the initial loan, because remember, refinancing is basically taking out another mortgage with a new lender. 

For example, a $200,000 loan could cost between $6,000 and $12,000 in fees. That will either need to come from your bank account or be tacked onto the loan. 

This may give you a little bit of pause if you’re planning to sell the house within the next couple of years, because you may not be in the home long enough to break even with your new interest rate and recouping some of those costs. 

You Could Get A Bad Appraisal

A bad appraisal can crush any real estate deal, even a mortgage refinance.

Variables such as foreclosures in your neighborhood or even homes being sold at less than market value could affect the value of your home, thus the lower appraisal. 

If your home is worth less than what you owe, you’re probably going to be hard pressed to find a lender that will want to offer you a refinance.

In this case, you’ll need to continue building more equity either through paying off more than the mortgage, or by waiting until home values start to rise.

Your Amortization Schedule Will Reset

When you take out a mortgage, most of the interest comes out in the first few years. So, going back to the same example, your $200,000 loan with 6% interest. 

At the end of the first year, you will have paid almost $13,000 in interest, but not even $3,000 in principle.

But in year 10, you’ll only pay about $9,000 in interest with about $4,500 going towards principal. 

You’ve gone from paying $10,000 more in interest every year to $4,500 more by year ten.

If refinancing is taking out a brand new loan, it will set you back to that year one ratio where you’re paying much more every year in interest.

If you’re still in the first couple of years of your mortgage, refinancing isn’t a bad deal. 

But, if you’re super deep into paying off your mortgage, say 10-15 years, you need to bust out a spreadsheet to see if refinancing is actually worth it, because in some of those cases you could end up paying more in interest with a refinance. 

Pay Attention To Changes In Your Loan Term

Refinancing to a shorter term means less money spent on interest over time. But you also need to consider if you could afford the potential higher monthly payment.

Refinancing to a longer term may lower your monthly payment, but you might be paying more in interest as well. 

Even refinancing when you’re more than a few years in can make it difficult to recoup a lot of the costs and fees.

It will also keep you making that payment a little longer.

If you’re 2-3 years into paying off your 15 year mortgage, refinancing puts you back on a 15 year term instead of the 12-13 years you had left when you refinanced.

You could also have a prepayment penalty within your mortgage. This could tack on additional costs if you’re within those first few years. 

Be sure to look at your mortgage paperwork, because you want to avoid any prepayment penalty.

You definitely don’t want any legal ramifications if you bought your home with a first time home buyer program and the fine-print has special rules to it ‘hidden.’

Even with rates being at historic lows right now, refinancing isn’t always the best option.

A good rule of thumb is that if you’re in your first handful of years and you can save close to a full percentage point, then a refinance is worth looking into. 

Have you refinanced your home? What was your experience like?

Let me know and if you have any questions about refinancing your mortgage, feel free to stop by the neighborhood which is our private online group and ask your question.