According to Freddie Mac, mortgage rates recently hit a record low for the 8th time in 2020. Historically low interest rates might mean huge savings for qualified homeowners. Refinancing when rates are on the decline could result in a new mortgage with smaller monthly payments or less paid in interest charges over the life of the loan. In either scenario, homeowners can free up cash for other financial goals, such as saving for retirement or starting an emergency savings account.
Before submitting a mortgage loan refinance application, homeowners should gain a basic understanding of their mortgage refinancing options.
What is a mortgage refinance?
A mortgage loan refinance allows you to pay off your existing mortgage with a new loan, usually with a revised interest rate, repayment schedule, or both. As with your original mortgage, your home serves as collateral for the new loan, so be aware that failure to repay the loan as agreed puts it at risk of foreclosure.
Why should you consider mortgage loan refinancing?
The main reason homeowners choose a mortgage loan refinance is to save money. However, refinancing can result in different savings benefits, making it crucial to know your reason for considering a refinance. For example, if your goal is to:
- Lower your monthly payments long-term, you might consider refinancing your 15-year mortgage to a 30-year term or refinancing your 30-year mortgage to a new 30-year term with a lower rate.
- Pay off high-interest rate debt, build your emergency savings, or perform major home renovations, you might consider a cash-out refinance.
- Build equity in your home sooner, you might consider refinancing your 30-year mortgage to a 15-year term.
- Take advantage of interest rates that continue to fall, you might consider converting from a fixed-rate to an adjustable-rate loan.
- Have stable and predictable monthly payments, you might consider switching from an adjustable-rate to a fixed-rate loan.
Even though refinancing offers homeowners an opportunity to improve their finances, there are other factors to consider.
Refinancing pros and cons
Wise homeowners compare available options before committing to a mortgage loan refinance. When weighing the pros and cons, you can discover the best choice for your financial situation.
Pros and Cons Based on Repayment Terms
Pros of refinancing your 15-year mortgage to a 30-year term:
- You can lower your monthly mortgage payment
- You have longer to repay the loan
- You can free up cash in your monthly budget
Cons of refinancing your 15-year mortgage to a 30-year term:
- You’re restarting the repayment timeline
- Long-term mortgage payments might interfere with your ability to achieve other financial goals
- A longer repayment term means you'll pay more in interest over the life of the loan
Pros of refinancing your 30-year mortgage to a 15-year term:
- You have the potential to save $1,000s in interest charges over the life of the loan
- You can be debt-free sooner
- You can redirect the old loan payment to other financial goals sooner than originally planned
Cons of refinancing your 30-year mortgage to a 15-year term:
- Monthly payments will increase
Pros of refinancing your 30-year mortgage to a lower rate:
- If your credit health has improved since you originated the loan, a higher credit score can help you qualify for a lower rate, resulting in a lower payment
- You can free up cash in your monthly budget
Cons of refinancing your 30-year mortgage to a lower rate:
- You’re restarting the repayment timeline
- Long-term mortgage payments might interfere with your ability to achieve other financial goals
- A longer repayment term means you'll pay more in interest over the life of the loan
Pros and Cons of a Cash-Out Refinance
Pros of completing a cash-out refinance:
- You can receive cash to use at your discretion
- Using funds to pay for a home renovation can increase the home's value
Cons of completing a cash-out refinance:
- Unless you have a comprehensive debt management plan, you risk using the money for purchases that bring little to no financial return
Pros and Cons Based on Interest Rate Type
Pros of converting from a fixed-rate to an adjustable-rate loan:
- If you plan on paying off the loan quickly, you might be able to do so at a lower rates when compared to fixed-rate loans
- You can reduce the interest rate on the existing loan
Cons of converting from a fixed-rate to an adjustable-rate rate loan:
- If interest rates increase, so might the payment
- Harder to stick to a budget since the payment might fluctuate
Pros of converting from an adjustable-rate to a fixed-rate loan:
- You can lower your monthly mortgage payment
- You can free up cash in your monthly budget
- You can reduce the interest rate on the existing loan
- Easier to budget since the payment does not change
Cons of converting from an adjustable-rate to a fixed-rate loan:
- You might miss out on further interest rate reductions and the associated savings
Borrowers may be able to combine refinancing benefits when interest rates fall. For example, refinancing a 30-year adjustable-rate loan to a 15-year fixed-rate loan could result in a shorter loan term, predictable payments, and significant interest savings for only a slight change in the monthly cost.
If you are looking to reduce expenses or meet other financial goals, refinancing your mortgage could help. However, since refinancing can cost between 2% and 5% of a loan's principal amount, you must figure out how long it will take you to recoup the costs to make refinancing worth it. A new loan that requires you to live in the home another eight years to break even when you're planning on moving in three may mean refinancing isn't the best choice.
Explore your refinance options with a mortgage professional. Discuss your specific situation with a home loan expert to uncover the benefits that await you and your finances.
