Should I Refinance My Home?
In Financing Your Home Purchase, by Anthony Bayardelle
What Does it Mean to Refinance Your Mortgage?
Refinancing your mortgage is basically using a second loan to immediately pay off (and replace) your existing mortgage. This leaves you with a different loan, which may have a different length, interest rate, or loan type.
In many situations this can be a great financial move, especially if you are able to secure a lower interest rate, a shorter-term, or lower monthly payments. People also often refinance to consolidate debt (which can be done in either a financially savvy or incredibly risky way), to switch loan types, or two get a large amount of cash in the short-term.
However, regardless of your reasons for refinancing, the biggest question you probably have is whether refinancing will save or earn you money in the long term.
Will Refinancing Save Me Money?
This is not an easy or simple question to answer, as it depends largely on the specifics of your individual situation. The only way to answer this question with 100% sure T is to talk to an actual, human loan specialist who can present you with a full range of loan options for which you qualify so you can compare them to your current situation.
However, in the instant gratification internet age, there are many useful online calculators that can give you a ballpark of what you stand to save by refinancing. here are a few of my favorites:
NerdWallet’s Refinance Calculator
Cacl XML’s Should I Refinance My Mortgage? Calculator
Smart Asset’s Refinance Calculator
Mortgage Calculator’s Refinancing Your Home Tool
If you put your specifics into one of these calculators and they indicate that you could save money by refinancing, talking to a lender might be your next logical step.
When contacting A lender about potentially refinancing, you want to talk to someone who is well-versed in loans from multiple companies and programs, not someone who just pedals their company's solutions. It's also important to note that the initial consultation should be free, so you probably shouldn’t trust someone who says they have to charge you for a report on your loan options.
Pros and Cons of Refinancing
Pro: You Can Reduce Your Monthly Payments
There are many situations in which refinancing your house could drastically lower not only your overall monthly payments but your interest rate, which means that more of the money you're paying is going to principal rather than to paying off interest to the bank.
This is especially true with the recent Trends in lower interest rates, so if you have had your mortgage for a while there's a high likelihood that you could refinance and save a great deal of money on your monthly payments.
Con: There Are Still Closing Costs
Just like when you finalized your initial mortgage, there will be closing costs associated with refinancing your home as well.
Closing costs for refinances are not standard, but usually range between 3 and 6% of your total loan amount. The variation comes from which lender you choose, your geographic location, your credit score, loan type, and the amount of equity you have already paid off on your home.
Before you put too much stock into the idea of refinancing your house, talk to a qualified lender who is familiar with multiple loan types to see what your actual financial figures would be and what closing costs you would be looking at.
Pro: You Can Save Money In the Long Term
One of the most common reasons for which people refinance their home is to secure a smaller monthly payment. However, you can also save money by refinancing into a lower interest rate or a shorter period of time for your loan term, both of which make you pay down more principal (which goes to your equity in the house) and less interest (which goes straight to your lender).
That being said, refinancing isn't the smartest Financial option in every situation. Next, we'll go over a list of potential indicators why it is or is not a good time for you to refinance your home.
When Should You Refinance Your Mortgage?
To Lock in a Lower Interest Rate
Overall, this is the most popular reason to refinance you're home. If you secured your original mortgage at a much higher interest rate than is currently present, the simple act of refinancing your house could significantly lower your total interest expense over time.
This is not always the case, so you want to do preliminary research by plugging your specifics into an online mortgage calculator and follow this up by talking to a qualified lender. however, in many circumstances people can significantly lower their monthly payments and the percentage they're paying towards interest.
To Switch Loan Types
As time goes by, has your financial situation changes, and as different loans come on to the market, it might be beneficial for you to switch from one type of loan to another. For example, if you initially had an adjustable rate mortgage (ARM) you might want to switch into a traditional mortgage to take advantage of low interest rates. however, in order to make this judgment you need to know the exact specifics of not only your current loan but also the loan alternatives that are available to you.
The best way to do this is to know your basic mortgage options. Talk to a qualified lender who specializes in loans from many different companies and knows all the options that are actually available in your specific situation. While it's not always the case, sometimes a strategic refinance to switch to a different loan type can save you a huge amount of money in the long run.
To Switch to a Shorter Term Loan
It is usually the case that shortening the term of your loan will significantly decrease the amount of interest you end up paying overtime. If you previously had a 30-year mortgage a relatively high interest rate, refinancing to a 15 year mortgage with a lower interest rate could save you a huge amount of money across the course of your loan and allow you to stop making payments earlier.
To Take Cash Out to Invest (Wisely)
This is where it's really important to know your financial figures backwards and forwards. If you are currently paying down a mortgage at an interest rate of 5 or 6% and you know you can make 12% on a specific investment opportunity, refinancing could be a great way to get the capital evening it. However, if you're taking money out of your house at a 5 or 6% interest rates and depositing it into a savings account or CD that only earn to you 2.5%, it would not be beneficial financial news.
Long story short, know your numbers. If you know what you're doing refinancing to fund your investment opportunities can be a very wise financial play, but if you don't strategize properly it can end up costing you money in the long run.
To Consolidate Debt (Wisely)
It is a very serious move to refinance your home to pay off credit card or other debt, but if properly thought out it can be a smart financial move.
If your debt was accrued because of a one-time unexpected expense, like unforeseen medical bills or repairing the damage from a natural disaster, It can be smart to refinance your home and pay interest at a lower interest rate than that on a credit card bill. As of 2019, the interest rate on an average 30 year traditional mortgage is 3.99% while the average credit card interest rate is 19.24%. It doesn't take a math major to see the benefits of paying over 15% less interest on your debt.
If done properly, rolling credit card debt into a mortgage refinance can save you a huge amount of money and interest payments over time. However, read the next section on all of the risks inherent to the idea of paying down credit card debt by refinancing your mortgage, because this scenario can also go very badly.
When is Refinancing a Bad Idea?
To Consolidate Debt (Stupidly)
There are two primary ways in which using a mortgage refinance to consolidate debt can go very wrong.
First, most credit card debt is not created by a single, unexpected, unavoidable expense (like medical bills or a family emergency). Most credit card debt comes from habitual overspending over a long period of time. Even if you consolidate your debt by refinancing your mortgage, there's a very high likelihood that the spending habits which created your debt in the first place I'm not going to magically disappear. This will leave you with a longer-term mortgage for a higher amount and a fresh supply of credit card debt.
Second, credit card debt is what is referred to as “unsecured debt”. This means that you can see a significant negative consequences for not paying it off, but you do not stand to lose any major possessions if you cannot pay. A mortgage is “secured debt”, which means that if you cannot make your payments your lender can foreclose on your loan and you will quite literally lose your house. This makes playing more debt into your mortgage a very risky financial move because, if there is any doubt that you will be able to make your payments, you don't want to gamble your home on it.
Overall, refinancing your house to pay off debt is not always a bad idea, but it can be done in a smart way or a very risky way. Make sure your situation and your financial specifics put you in the first category before you proceed with a refinance if you are doing it to eliminate other debt.
To Take Advantage of a “No-Cost” Refinance
It is exceedingly rare to have an actual “no-cost” refinance. In the best-case scenario, you now qualify for a loan that is far better than your original loan, so you end up saving more than you spend and recouping your money in a very short amount of time, but usually when people claim to have a “no-cost” refinance it really just means that they costs wrapped up into the loan so they didn't have to pay them up front as costs.
If the only reason you are choosing to refinance is that someone told you it would be free or low-cost, not only is that is not usually true, but it is definitely not sufficient justification to make a major financial move like a home refinance.
If You’re Planning to Move
As we talked about above, there is no such thing as a “no-cost” refinance. There will always be some type of closing cost or fee associated with it, but these costs are usually a minimal amount compared to how much money you will save by refinancing so they are worth it in the long term. However, these savings only accrue overtime, so if you're planning to move in the next few years, it usually doesn't make sense to refinance your home.
The potential savings of a refinance will not occur in the time frame you're actually planning on being in the home, so all you will be left with is the cost of the refinance.
If You’re Moving into a Loan with a Longer Term
If you have 15 years left on a 30-year mortgage and you refinance into another 30 year loan, you are committing yourself into 15 extra years of interest payments. Yes, the principal will theoretically stay the same, but the amount of interest you will end up paying will be far greater than if you had stuck with your original mortgage.
This isn't to say that extending your loan with a refinance is always a bad idea, but you should definitely take this into account when weighing your options. Also, don't neglect the fact that even if your payments are lower each month, you'll be making them for a longer period of time if you link them the span of your loan.
To Take Cash Out to Spend
This is usually the biggest red flag.
Even though refinancing your mortgage could give you cash or lower monthly payments in the short-term, you were still taking out a loan for whatever money you get. Unless you have a significant investment opportunity that could earn you more money than a refinance would cost you, it is typically not a good idea to refinance your mortgage for spending money.
Frequently Asked Questions
Can I Refinance with No Closing Costs?
We touched on this one above, but the answer is almost always no.
You can get a refinance with low closing costs and you can wrap them into the principal of the loan so you don't have to pay them up front, but the closing costs on a refinance mortgage are comparable to that on the closing costs on the mortgage you got in the first place, between 3 and 5% of the total loan amount.
Do I Have Enough Equity to Refinance?
The more equity you have paid down already on your existing mortgage, the better a deal you can usually get on a refinance.
When assessing the amount of equity you currently have, you will hear the term LTV quite often. This is a percentage between 0 and 100 that represents how much equity you have paid in comparison to the value of your property. If your house is worth $600,000 and you have paid down $300,000, your LTV would be 50%.
Overall, the higher your LTV the less risky your loan will seem to potential lenders and the easier it will be to refinance. An added benefit, if your LTV is 80% or lower, you will not have to pay for private mortgage insurance or PMI.
Is My Credit Score High Enough to Refinance?
Even though you are refinancing your home, the same credit score rules that applied to your initial mortgage apply to whatever new loan you'll be moving into. It depends on what type of loan you are getting whether your credit score is high enough.
If you have any doubt about this, any qualified and knowledgeable lender will be able to take a look at your credit and give you a comprehensive list of the loan options that are available for your specific financial situation.
Do You Get Money Back When You Refinance Your Mortgage?
In what is referred to as a “cash-out refinance”, you can secure mortgage for a larger amount than what you still owe on your home and take home the difference in cash.
While this is necessary in some circumstances, is definitely not something to be done lately. As previously discussed, mortgages (even when refinancing) come with closing costs, longer loan terms, or significant amounts of Interest, so you want to make sure that the benefits of getting short-term cash far outweigh the long-term detriments of a larger or longer-term loan.
Also, it should be noted that a Cash out refinance has more restrictions then if you were to refinance for other reasons. You could be denied by lenders if you don't have a minimum credit score, if you're LTV is too high, or if you have not owned your home for at least a year.
Does Refinancing Hurt Your Credit?
Unfortunately, refinancing your home can affect your credit score. In order to refinance you will need to run a hard inquiry credit check, which may cause a temporary drop in your credit score. to minimize this impact, try to make all of your loan inquiries within a 45-day window, as most credit score will treat multiple inquiries within this window as a single inquiry, thus minimizing the damage to your credit score.
similarly, you are closing the loan on your previous mortgage, which can also negatively impact your credit card score as it is closing a long-standing credit account. however, as long as you are closing your previous mortgage in good standing this shouldn't be a huge detriment to your credit score, and whatever small dip you see will be quickly remedied as you resume payments on your new mortgage.
To avoid any real damage to your credit score, just make sure to pay attention to the payments that are necessary when switching over from one mortgage to another. Make sure that even if you are new loan pays off the old loan, the payment arrives promptly enough not to accrue late fees and affect your credit score in a negative way. This is yet another reason why working with a qualified and competent loan officer is so important, because little details like this can be missed and will affect you and your credit score.
What Do I Need to Refinance My Home?
Finally, the most important thing you need to refinance is a qualified and knowledgeable mortgage lender. You want someone who knows all the different loan options and possibilities that will be applicable to your individual situation, not just someone who's selling their company's branded loan or mortgage.
Talk to someone who knows their stuff, have them look at your specific situation and financial information, and they will give you a comprehensive (free) report of what your options actually are.
If you don't have a mortgage lender you trust, fill out the contact form below for a free 15 minute phone consultation. With a few key bits of information I can get you exactly what your options would be and a financial analysis of whether or not refinancing will be right in your specific circumstances.