By Andrew Housser
Beginning in 2012, homeowners hurried to refinance their mortgages as interest rates fell to historic lows. Refinancing replaces an existing mortgage with a different one. Most people refinance to obtain better loan terms and interest rates. While interest rates now have increased slightly, they still remain near historic lows.
Depending on your current financial situation, refinancing may or may not be a wise move. Before making the decision, carefully consider these pros and cons.
Benefits of Refinancing
1. More money in your bank account. If you refinance to get a lower interest rate, the result will be a lower monthly mortgage payment. The key, of course, is to be smart with the “extra” cash you will have. Wise consumers will use the funds to pay off debt, such as credit cards or student loans, or beef up emergency savings.
2. A secured interest rate. If you have an adjustable-rate mortgage or ARM (also called balloon or variable-rate), your interest rate – and therefore your mortgage payment – will increase eventually, depending on the terms of your loan. Refinancing to a fixed interest rate may save money over the long term, even though it may increase your interest rate and payment in the short term. It also ensures that you will not have a spike in payments in a few years.
3. Access to extra cash. A cash-out refinance loan allows you to refinance your mortgage for more than you currently owe and keep the difference. This may sometimes be a viable option if you need to pay for major house renovations like replacing a roof or windows. Some people find it necessary to help pay for a child’s college tuition. Others might pay off out-of-control credit card debt. If your goal is to pay outstanding debt, make sure you have a plan in place for dealing with your credit card use before you refinance. If you continue to rack up charges, you will simply end up with a bigger mortgage and credit card debt.
4. Faster mortgage payoff. Depending how low interest rates are, you may be able to get a shorter-term mortgage that you can pay off faster without significantly increasing your monthly payment.
Drawbacks of Refinancing
1. It will cost you. Refinancing costs may include an origination fee for applying and processing. You also may pay discount points (may be tax-deductible), and settlement charges including payments for appraisals, title searches and credit reports. You also may face a penalty for paying off your current loan early. Closing costs associated with refinancing can amount to thousands of dollars. Nationally, closing costs on a $200,000 loan in 2012 averaged $3,754. Since it takes time to recoup this amount in interest savings, experts suggest refinancing only if you do not plan to move within the next few years.
2. Your home may be at risk. If you are considering a cash-out refinance to pay off credit card debt, make absolutely sure you are able to do that and continue to make your mortgage payments, in full and on time, each month. If you can’t make credit card payments, you will receive collections calls and your credit rating will suffer. But if you can’t make your mortgage payment, your home becomes at risk for foreclosure.
Talk to your current lender if you are considering refinancing. Most require borrowers to make payments on a mortgage for at least 12 months before refinancing. After that period, lenders often would rather offer a better rate to existing customers in order to keep the business. As an added bonus, you might save money if your current lender does not require a new title search or appraisal.
Whatever you decide, evaluating a possible refinance does not hurt. To protect your credit, compare refinance lenders all at once, so that they all check your credit history simultaneously. This minimizes the effect of credit checks on your credit score. Then use your lower payment or better terms to improve your financial state – now and in the future.
Andrew Housser is a co-founder and CEO of Bills.com, a free one-stop online portal where consumers can educate themselves about personal finance issues and compare financial products and services. He also is co-CEO of Freedom Financial Network, LLC providing comprehensive consumer credit advocacy and debt relief services. Housser holds a Master of Business Administration degree from Stanford University and Bachelor of Arts degree from Dartmouth College.