Mortgage refinancing can provide a range of financial benefits, from helping you improve your cash flow to saving you money. But it is not the best move for everyone, even when mortgage interest rates are low.
Refinancing does have several potential downsides to consider. For example, refinancing a mortgage can be time-consuming and expensive with closing costs. It will also require a hard credit check, which can temporarily lower your credit score.
Here are seven scenarios in which refinancing can provide significant benefits, but can also have negative consequences on your finances.
- Whether refinancing your mortgage is a good idea depends on your goals and financial situation.
- When you refinance, you may pay more in the long-term if you have a higher interest rate or a longer loan term.
- Refinancing often entails fees and closing costs.
1. To Consolidate Debt
Consolidating debt can be a positive financial move in certain circumstances, such as if you lower your interest rate or monthly payments. If you refinance a loan to consolidate debt, you can also potentially compound your debt if you don’t budget responsibly.
Once you have repaid your credit card debt, you may tempted to spend again. Of course, this will build up new balances.
When you refinance unsecured debt, such as a credit card debt, with debt that is backed by your home, you can increase your risk of losing your home. If you are unable to make your mortgage payments, you can lose your home.
2. To Move Into a Longer-Term Loan
While refinancing into a mortgage with a lower interest rate can save you money each month, look at the overall cost of the loan, especially if you are trying to save money in the long-term.
A longer-term loan could result in lower monthly payments, but higher overall costs. For instance, if you have 10 years left to pay on your current loan and you refinance to a 30-year loan, you could end up paying more in interest overall to borrow the money and have 20 extra years of mortgage payments.
Use a mortgage calculator to help you estimate the savings or additional costs of refinancing.
Your lender may disqualify you from refinancing your mortgage if you carry too much debt. Your debt-to-income ratio must meet your lender’s thresholds for you to qualify. Having a low credit score may also prevent mortgage lenders from approving your application.
3. To Save Money for a New Home
As a homeowner, you need to make an important calculation to determine how much a refinance will cost and how much you will save each month. If it will take three years to recoup the expenses of a refinance and you plan to move within two years, you are not saving money.
4. To Switch From an ARM to a Fixed-Rate Loan
For some homeowners, switching to a fixed-rate loan from an adjustable-rate mortgage (ARM) can be an excellent move, particularly if you intend to stay in the home for the long-term and interest rates are low. But carefully consider the terms of the fixed-rate loan before making a move to refinance.
If you have an ARM, make sure you know:
- The index to which its rate is tied
- How often the loan adjusts
- The caps on loan adjustments (first cap, annual cap, and lifetime cap)
5. To Take Cash Out for Investing
You may be tempted to refinance to take cash out of your equity to invest for returns. This may be a good move if you secure higher returns than the interest rate on your refinanced mortgage. But keep in mind that there is a risk of loss with every investment.
If you refinance, then lose money, you will end up in a worse financial position than if you had not refinanced. The most conservative investments, such as savings accounts or certificates of deposits (CDs), often have rates of return that are lower than mortgage interest rates.
Make sure you understand both the risks before investing money you receive from refinancing your home.
6. To Reduce Your Monthly Payments
Reducing your monthly payments by lowering your interest rate makes financial sense. But there are costs associated with refinancing. In addition to the closing costs and fees, which can range from 2% to 3% of your home loan, you will be making more mortgage payments if you extend your loan terms.
If, for example, you have been making payments for seven years on a 30-year mortgage and refinance into a new 30-year loan, you will be making seven extra years of loan payments. The refinance may still be worthwhile, but you should include those costs in your calculations before making a final decision.
Compare the amortization schedule of your current mortgage to the amortization schedule of the new mortgage to understand the financial impact of a refinance.
7. To Take Advantage of a No-Cost Refinance
A no-cost mortgage can help you avoid paying for closing costs, but you may end up paying more in other ways. Lenders may simply include the closing costs in the overall loan amount, which will increase the size of your principal.
Or, the lender may charge a slightly higher interest rate or include closing points in the loan. Calculate the best way for you to pay the costs by comparing the monthly payments and overall costs for each scenario before choosing the loan that works best for your finances.
How Often Can You Refinance Your Home?
There are no regulations that cap how often you can refinance your home, but lenders typically set their own limits. Some also impose prepayment penalties on existing loans. Your ability to refinance also depends on the equity you have in your home and your credit score. If your score is lower than the last time you refinanced, you may not get approval from your lender.
Finally, keep in mind that every time you refinance, you’ll pay closing costs and fees which can take years to recoup. Lenders will also pull your credit, which can temporarily negatively impact your credit score.
Should You Refinance Your Mortgage?
Whether you should refinance your mortgage will depend on several factors about your financial situation and goals. Refinancing can save you money if you get a lower interest rate, but you could also end up paying more if you refinance simply to extend the loan term. Refinancing can help you consolidate debt or tap your home equity for extra cash for renovations, but it can also lead to more debt.
When Is the Best Time to Refinance a Mortgage?
If you want to refinance your mortgage, the best time is when interest rates are lower than your current interest rate. This allows you to save money on interest, lower the amount of your monthly payments, or shorten your loan term.
Will It Be Hard to Refinance My Mortgage?
The process for refinancing is typically significantly shorter than getting your primary mortgage. However, you may have to go through some of the same processes, like completing the application and going through a credit check. You may have to get an appraisal as well.
The Bottom Line
Refinancing a mortgage can be a wise financial move for many homeowners, but not every refinance makes sense. Be sure to evaluate all your options before making a decision. Consider consulting a financial advisor to review your options for reaching your financial goals.