Pro and cons of refinancing a home

Are you considering refinancing your home to get your hands on some cash or reduce the interest on your current mortgage? Maybe you’ve already calculated your new mortgage payment and are ready to refinance today. Refinancing can be a smart move, but there are points to consider before signing any paperwork.

While there are many reasons to refinance your home – first and foremost, a person needs to be able to afford it – only some of those reasons will truly support your unique needs. By going through the following list, you’ll be able to tell which options apply best to you.

Positive reasons to refinance a home

1. You want to lower your interest rate

Lowering your interest rate is the best reason to refinance your mortgage. Investopedia recommends refinancing if you can reduce your interest rate by at least 2%. Lenders will say you should refinance if you can save 1%, but that may not be worth the effort, depending on your preferences.

When the interest rate decreases, equity will build faster as more of your payments will go to the principal. Additionally, you’ll pay less monthly.

2. You want to switch to a fixed-rate loan

Without a fixed-rate loan, you’re subject to periodic adjustments that can increase your payments. A fixed-rate loan will give you a stable, lower interest rate that won’t skyrocket on a whim.

3. You want to shorten your loan’s term

If you can refinance your mortgage and get a shorter loan term while maintaining payments that are about the same or less, that’s a positive reason to refinance. It’s possible to cut a loan term in half by reducing the interest rate by the same amount. 

Although, if you’re already getting a low interest rate, this probably won’t make much of a dent in your particular loan.

4. You want to ditch private mortgage insurance

If you were required to purchase private mortgage insurance, refinancing could allow you to eliminate this extra cost. However, your lender will probably require you to have at least 20% equity to eliminate a mortgage insurance policy.

Negative reasons to refinance a home

1. You need money for personal reasons

Refinancing will save money, but it will also require payments upfront. If you’re refinancing your home to get money for personal reasons, the closing costs will most likely be outside of your budget. Refinancing a home is basically the same as taking out a new mortgage on a home and will incur all the usual fees.

Furthermore, if you need money for personal reasons, there are other ways to earn an income without putting your home in jeopardy. For example, you can take out a personal loan, a bad credit loan or ask friends and family for a loan.

2. You want to pay off your student loan debt

Paying off your student loan debt is important, but it’s not worth refinancing your home to earn a supplemental income. If you need money to pay back your student loan, consider getting a deferment or making smaller payments that fit your current financial situation. It doesn’t make sense to go into debt to pay back debt, especially if your house is on the line.

3. You want lower payments

Everyone wants a lower monthly mortgage payment, but it’s not usually worth refinancing your home to make that happen. Most of the time, to get lower monthly payments you will be required to accept a longer term for your loan. That means it will take you a prolonged length of time to pay off your mortgage and you’ll pay more interest along the way.

If the length of a loan is extended when it’s at least halfway paid off, you’ll be starting from scratch in terms of paying interest first. It will be a long time before you’ll start paying down your principal, which means you won’t build equity for a long while.

Lowering monthly payments by extending the term of your loan won’t save money in the long run. Whatever savings you receive each month will be paid back in other ways through interest, more monthly payments and closing costs.

Consider refinancing carefully

Before refinancing your home think about the reasoning behind your motives carefully. Do you really need to refinance, or is there another way to achieve your goal? 

Make sure you’re refinancing your home for the right reasons. If you feel that you’re in over your head with your current loan, it may be of interest to consider downsizing to a smaller home or selling your home and renting an apartment for a while. 

The effects of your decisions today will affect you for many years to come, so don’t make any conclusions until you’ve taken the time to weigh all of your options and assess their outcomes.

The editorial unit

The material contained in this article is of the nature of general comment only and does not give advice on any particular matter. Recipients should not act on the basis of this article’s information without taking appropriate professional advice.