Pros and cons of refinancing mortgages
Quick insights
- There are several potential benefits that can come from refinancing your current mortgage with a new one, such as lowering your monthly payment.
- Mortgage refinance rates may be lower than your current rate, allowing you to lock in a better rate and save on interest charges.
- Running the numbers and calculating your break-even point can help to determine when it is a good time to refinance your mortgage.
Depending on current interest rates and your loan terms, you might be looking for opportunities to lower expenses, especially your monthly mortgage payment. Could mortgage refinancing be the right financial opportunity? Let’s cover the process and explore the pros and cons of refinancing.
What is refinancing a mortgage?
Refinancing a mortgage means you replace your old mortgage with a new one. This is a new loan on your property that hopefully has a more favorable rate and loan term that work for your budget.
Two common forms of mortgage refinancing are:
- Cash-out refinance: When you get a new, larger home loan, but maintain some home equity. You get the difference between the new loan and the existing loan in cash to use how you’d like.
- Rate-and-term refinance: When you replace your current mortgage with a new one—the interest rate and loan term are the main things that change. Ideally, the result is a lower interest rate, monthly payment or both.
Benefits of refinancing a mortgage
Refinancing a mortgage can provide several potential advantages depending on your financial goals, current loan and equity position. Here are some examples of when it might make sense to refinance:
- Potentially lower interest rates: If current interest rates are lower than those on your existing home loan, refinancing could reduce your rate. For example, switching from a fixed interest rate of 6% for a 30-year mortgage to a 5% interest rate could lower your monthly payment while keeping the same loan balance.
- Interest savings over time: By lowering your interest rate or switching to a shorter mortgage term, you may pay less interest overall. For instance, moving from a 30-year mortgage to a 15-year mortgage could increase your monthly payment but reduce the total interest paid by a significant amount. Refinancing to a shorter term can help you pay off your mortgage faster and build equity sooner.
- Access to a lump sum of cash: A cash-out refinance means getting a new, larger mortgage but leverages your home equity to get cash. You might use this for home renovations, debt consolidation or other financial priorities.
- Manage your budget more effectively: Refinancing may provide more predictable or manageable monthly expenses. This budgeting can help you plan for other goals, save for emergencies or allocate funds toward an investment property.
- Eliminate or reduce private mortgage insurance (PMI): If your home has gained enough value, refinancing could remove PMI, lowering your monthly mortgage payment. For example, a homeowner with a 20% increase in home value might refinance and eliminate PMI, saving money each month, depending on the loan size.
- Consolidate high-interest debt: Some homeowners use cash-out refinancing to pay off credit cards or other high-interest loans. This can streamline debt payments and may reduce overall interest costs.
- Take advantage of flexible loan features: Refinancing may allow you to switch from an adjustable-rate mortgage (ARM) to a fixed-rate loan for more stability, or vice versa, if you want lower initial payments. For example, moving from a 5/1 ARM to a 30-year fixed-rate mortgage can help protect your budget from future interest rate increases.
Cons of refinancing a mortgage
As with anything in life, refinancing a mortgage has its advantages and disadvantages. There are a few reasons you may not want to refinance your home, such as:
- Additional costs: When you refinance, you have to pay closing costs, which can range from 2 to 5% of the new loan amount. There are upfront costs that come with refinancing your mortgage. Make sure you set aside enough funds to cover additional expenses like closing costs.
- Credit score decrease: If you refinance a mortgage, your credit score might decrease. Depending on your payment history and activity going forward, the decrease may be temporary.
- More interest: There are unique situations where you could end up paying more in the long term, such as taking out cash from the property or extending the loan term. For rate-and-term refinances with extended terms, customers may pay more in interest.
In summary
There are various pros and cons of refinancing a mortgage. Your current financial situation, mortgage terms and broader economic trends come into play. Before refinancing, there are short- and long-term considerations that can help you decide—the terms, mortgage refinance rates, costs and break-even point, for example.
If you have questions about whether mortgage refinancing is right for you, we’re here to help.
