The Benefits and Drawbacks of Mortgage Refinancing
If you have already purchased a home or taken out a loan to buy a home, you will likely be familiar with the term "refinancing." In this article, we will define refinancing and investigate its various pros and cons.
Simply put, refinancing involves taking out a new loan to pay off an existing one - specifically, your mortgage. People will generally opt to refinance to secure more favorable loan terms, such as a lower interest rate, a shorter loan term, or lower monthly payments.
While it's a financial move that can offer significant benefits, it also has its drawbacks. So before you decide to refinance, it's essential to consider some key factors and examine its pros and cons.
Pros of Refinancing
Refinancing can potentially bring a host of benefits to your financial situation. According to professional Colorado mortgage lenders, the most notable advantages of refinancing a property are as follows:
1. Lower Interest Rates and Monthly Payments
Securing a lower interest rate can lead to long-term savings. For example, if interest rates have dropped since you first took out your loan, refinancing could help you pay less in interest over the life of the loan. In effect, this adds up to significant savings over time.
2. Shorter Loan Terms
A shorter loan term is one of many benefits of refinancing, especially if you want to repay your loan faster. Your monthly payments may be higher, but you'll pay less interest and repay your loan faster.
3. Add or Remove a Co-borrower or Cosigner
Refinancing lets you remove a co-borrower who originally applied for the mortgage or add a new co-borrower with an excellent credit and income record, which may help get better rates and conditions.
4. Eliminate Private Mortgage Insurance (PMI)
Conventional home loans and down payments of less than 20% of the home's value may require you to pay for private mortgage insurance (PMI) to protect the lender from potential default. However, PMIs can be problematic since they can significantly raise your monthly mortgage expenses.
Increasing your home's value and paying off a portion of your loan may give you the required 20% equity to avoid paying for a PMI. By refinancing to a new loan with the updated home value calculation, you can now say goodbye to PMI, potentially saving you between 0.2%, 2%, or more of your loan balance annually.
Cons of Refinancing
Here are some of the drawbacks of refinancing to consider:
1. Closing Costs
Refinancing involves obtaining a new loan, which means paying closing costs such as appraisal fees, loan origination fees, and title insurance, among other things. These fees can be significant depending on the size of your loan.
2. Longer Loan Terms
While refinancing might lower your monthly payments, it may also lengthen the duration of your loan. Therefore, if one of your priorities is to pay off your debt as quickly as possible, refinancing may be counterintuitive.
3. Negative Impact on Credit Scores
When you apply for a mortgage refinance, lenders will often conduct a hard credit inquiry to evaluate your credit report and determine your eligibility for the loan. The hard inquiry will remain on your credit report for two years and may lead to a temporary dip in your credit score for several months.
Hard inquiries or account closures, which negatively affect your credit score, are unavoidable when refinancing. However, making timely payments towards your new loan will counteract the negative effects of refinancing on your credit score and, in the end, likely improve your credit score.
4. Potential Loss of Equity
If you choose a cash-out to refinance, remember that you may lose home equity. You'll be incurring extra debt, which might have long-term consequences if the value of your property doesn't rise or you run into financial troubles.
5. Potential for Hidden Fees
When refinancing your mortgage, watch for hidden costs in the fine print. Lenders may impose fees for underwriting, loan processing, or document preparation, so read your loan conditions carefully and ask questions if you need clarification.
Key Takeaway
Refinancing has two sides to it. On the positive side, it may help you lower your monthly payments, eliminate a co-borrower or private mortgage insurance, and shorten the length of your loan. On the negative side, refinancing can negatively influence your credit score, resulting in equity loss, longer loan terms, and more charges.
Whether to refinance your mortgage or not will be determined by different circumstances and what you need. The most important step you must do is to identify and comprehend the loan possibilities accessible to you.
Sometimes, just knowing the pros and cons of refinancing isn't enough. To be on the safe side, you may need to consult experts who have local expertise, knowledge, and years of experience that allow them to offer the most flexible mortgage and refinance rates in your state.
