Refinance Pros and Cons

By Daniel Duffield

Determining Whether Refinancing Your Mortgage is Worth the Cost

The majority of homeowners obtain refinance loans at some point during the lifetime of their mortgages. These refinance loans can greatly reduce the overall cost of the mortgage in some cases and are frequently used in order to secure lower interest rates. However, home refinancing includes costs as well and may not always be the best option. To determine whether a refinance is right for your circumstances, this article will explore the pros and cons of refinance loans, including the benefits of refinancing as well as the costs and pitfalls.

Home Refinancing Advantages

1.       Lower Interest Rate.

With today’s low mortgage rates, the most significant benefit of home refinancing is currently the ability to obtain a lower interest rate and thereby reduce one’s monthly mortgage payments, as well as the overall cost of the loan. Over the lifetime of a loan, even small differences in rates can translate to thousands of dollars saved or spent. As such, borrowers with mortgages acquired prior to the drop in mortgage rates stand to benefit substantially by refinancing to a lower rate, although determining the profitability of a refinance will vary from case to case.

2.       Adjust Mortgage Term.

Another advantage of refinancing is that it allows borrowers to adjust their loan term to fit their circumstances. For instance, if a borrower obtained a 15-year fixed-rate mortgage (FRM) but cannot afford to keep up with payments, he or she can extend the loan term to a 30-year FRM with a higher rate but reduced monthly payments. Conversely, borrowers who have seen a growth in their income can lessen their loan term from a 30-year FRM to a 15-year FRM with higher monthly payments but at a significantly reduced interest rate with a substantially lower overall loan cost.

3.       Change Repayment Type.

In addition to being able to change the mortgage term, homeowners can refinance their existing mortgages in order to change the repayment plan of the mortgage, switching from an adjustable-rate mortgage (ARM) to a fixed-rate mortgage, or vice versa. While adjustable-rate mortgages typically carry lower mortgage rates, they inherently involve more uncertainty and risk for borrowers, and a refinance can be an effective way to remove this risk to opt for a more stable monthly mortgage payment that won’t potentially increase. By contrast, borrowers who would prefer to assume some risk can switch from an FRM to an ARM for reduced mortgage rates.

Home Refinance Drawbacks

1.       Closing Costs and Fees.

As with standard home loans, refinance loans include closing costs that can detract from the benefits of refinancing. With application fees, loan origination fees, appraisal fees, and other expenses, borrowers may have to wait a while before breaking even with the reduced mortgage rates. Furthermore, borrowers with mortgages that include prepayment penalties must pay the entire sum of the remaining interest on the loan when obtaining a refinance loan, making it considerably less worth the cost.

2.       Less Beneficial in Short Term.

Homeowners considering a move within the near future will benefit significantly less from a home refinance than borrowers hoping to continue living in the home for the full duration of the loan. Essentially, this is because the savings of a home refinance will only be received after the loan “breaks even,” or when the cost of obtaining the refinance loan is exceeded by the benefits of the lowered interest rates and reduced mortgage payments. As such, refinancing is not advisable for borrowers who intend to move sometime soon thereafter.

3.       Difficult to Qualify.

As a result of the turbulence of both the real estate and mortgage markets at the turn of the last decade and the ongoing housing recovery, lenders have become much stricter about refinance qualifications and approval. With the exception of the FHA Streamline Refinance, refinance applications typically involve a large amount of documentation and verification, comparable to a home purchase mortgage application. Moreover, borrowers who have seen a credit score decline may end up being offered a higher mortgage rate, defeating the purpose of the refinance. Not only that, but some homeowners may find themselves unable to refinance if their property value has declined, in which case a HARP refinance may be the only answer.

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