When interest rates are really low, refinancing your home loan may seem like a no-brainer. But while there are some definite advantages, refinancing is a serious financial transaction and is not without risks. Before you decide it’s time to take out a new mortgage, ask yourself these questions and compare these pros and cons.
Do you have enough equity?
If your home is now worth more than you owe on your current mortgage, refinancing at a lower rate could be a good choice.
Is your credit score good enough?
Refinancing your mortgage comes with the same income and credit requirements as getting your original mortgage did, so if your credit history has suffered in the time since, you may not be eligible for a new mortgage.
How long are you going to stay in your current home?
When you refinance, you’re basically closing out your existing loan and taking out a new one. This process can include costs like a property appraisal, title insurance and others. You’ll need to calculate how long will it take the monthly savings of your new interest rate to “pay off” these costs. If you are considering moving soon or think you will outgrow your home, refinancing isn’t for you. If you move within a few years of refinancing, the savings likely won’t outweigh the closing costs.
How much of a rate reduction can you actually get?
If you can’t obtain a locked-in rate reduction of at least one-half of 1 percent, refinancing may not make sense for you. Many financial experts advise refinancing when rates are at least two points lower than your current mortgage’s rate.
Reducing your monthly payment or overall loan debt with a lower interest rate or shorter loan term (or both), saves you money each month, but it can have a bonus benefit too: If it makes it easier to pay your other bills, you can pay down other debts and increase your credit worthiness.
Increasing property value.
Refinancing with a cash-out option is a convenient way to get money for large purchases or expenditures such as home improvements, which if done correctly, can raise the value of your home at the same time your mortgage is decreasing.
High closing costs.
If you focus only on the interest rate of a new mortgage, you’re missing the overall picture. Closing costs can be as low as hundreds of dollars and as high as several thousand dollars. To make sure you’ll save money, you have to compare rates, terms, closing fees and points.
Not all homes go up in value, so if yours has not, or if it has lost value, a refinancing appraisal will reflect this and will affect the rates and terms lenders will offer you.
Not reading or understanding the loan documents.
When it comes time to close on your new loan, there could be more than 50 pages of important legal documents for you to sign. It is important to carefully read them and make sure there are no inaccuracies or mistakes that could end up costing you a lot of time and hassle to correct later or worse, cost you money.