Pros and Cons of Refinancing Your Home

The main benefits of refinancing your home are saving money on interest and having the opportunity to change loan terms. Drawbacks include the closing costs you’ll pay and the potential for limited savings if you take out a larger loan or choose a longer term.

Refinancing your home loan can have big benefits, such as saving you money on interest costs or giving you the option to cash out some of your home equity. Refinancing can be particularly beneficial if you have strong enough credit to qualify for good terms on the new loan and your long-term savings will easily offset the upfront fees. But refinancing isn't always worth it. You could get a longer repayment term or a larger loan and end up paying more over time or going into more debt. In the end, certain circumstances make refinancing a solid choice, while others might mean it's time to pause and reevaluate.

These are the pros and cons that you'll want to weigh before refinancing your mortgage;

Pros of Refinancing Your Home

There are many reasons why a mortgage refinance could be on your mind, especially when interest rates are increasing and you'd like to lock in a low fixed rate before they rise further. While rates are going up this year, you may still be able to save money if your current rate is high. But the advantages of refinancing go beyond the potential savings. Consider these pros:

Potentially Lower Interest Rate and Monthly Payment

One of the most common reasons to refinance is to get a lower interest rate. That may happen if your credit has improved since you first applied for a mortgage or if lenders are currently offering low rates due to market conditions. Refinancing can lead to big savings, especially if you also shorten your repayment timeline. You could also decide to refinance in order to opt for a lower monthly payment by choosing a longer repayment term.

If your credit is on the lower side—typically below 620 on an 850-point scale—refinancing isn't out of the question. The Federal Housing Administration (FHA), Veterans Administration (VA) and U.S. Department of Agriculture (USDA) all have programs that cater to borrowers in your situation.

Ability to Get Rid of Private Mortgage Insurance

When you get a conventional home loan and put down less than 20% of the home's value, you'll likely have to carry private mortgage insurance (PMI) to protect the lender from the risk you'll miss payments. PMI can add hundreds of dollars to your monthly mortgage costs.

But if your home's value has gone up, and you've perhaps also paid down part of your loan balance, you may now hold at least the 20% equity you need to avoid PMI. That means you can refinance to a new loan, using the new value of your home to make the equity calculation, and get rid of PMI. That will save you 0.2% to 2%, or more, of the loan balance per year.

Option to Change Loan Features

You can save money by refinancing to a shorter loan term or get a lower monthly payment by refinancing to a longer loan term. You could also switch from an adjustable-rate mortgage to a fixed rate, which is particularly attractive in a market in which rates are expected to increase.

You Can Add or Remove a Co-Borrower or Cosigner

If you first applied for a mortgage with a cosigner or co-borrower, such as a former spouse, you can refinance to a new loan and remove that individual. Or, if you'd like to add a new co-borrower―perhaps a new spouse with a very strong credit and income profile, who can help you qualify for the very best rates and terms—you can add them to the new loan.

Option to Cash Out Part of Your Equity

A cash-out refinance lets you take out a new, larger loan and take the difference between your prior and new loans in cash. That can be helpful if you're looking to pay off high-interest debt, like credit card debt, or fund a child's college education. You'll need to have equity in your home in order to qualify, and a cash-out refinance is a good idea only when you'll receive a lower rate than before as a result of the refinance.

Cons of Refinancing Your Home

A mortgage refinance isn't a no-brainer. There are still some downsides, starting with the amount it could cost. Here are the cons to be aware of:

Closing Costs

Refinancing your mortgage will come with closing costs of 2% to 6% of the new loan amount. These fees include appraisal fees, origination fees, attorney fees and more. You might be able to negotiate down some fees, and costs will likely differ depending on the lender you choose.

It's smart to compare offers from multiple refinance lenders, including the one you have your current mortgage with, to find the best terms.

Potential Negative Impact on Your Credit Score

When you apply for a refinance, the lender will conduct a hard credit inquiry in order to view your credit report, and to decide whether to work with you. A hard inquiry will stay on your credit report for two years, and could lead to a drop in your credit score that lasts a few months. Your prior mortgage will also appear as a closed account on your credit report when you refinance, which may also initially cause a drop in your score.

You won't be able to avoid this account closure or the hard inquiry when you refinance, and your credit score will probably improve as you make on-time payments toward the new loan. But keep in mind the potential effect on your credit score if you're planning to apply for another type of credit in the near future.

Potential for a Longer Loan Term or More Debt

When you refinance to a longer loan repayment period or you choose a cash-out refinance, it's important to balance the short-term benefits with the longer-term impact. Due to interest costs, you may pay more over the life of your mortgage loan if you refinance to a longer-term loan—even if your monthly payments are smaller. And if you take out a larger loan as part of a cash-out refinance, your debt-to-income ratio will rise, potentially making repayment more difficult or making it harder to borrow more in the future. Source