Refinancing Your Mortgage: Understanding the Advantages and Risks

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With the current low interest rates, a refinance might look tempting. Whether you want to lower your monthly payments, save on interest in the long run, or pay off your mortgage faster, there are plenty of good reasons to refinance.

But before you rush into refinancing your mortgage, be aware that there are certain costs, disadvantages, and risks to refinancing as well. Here’s what you need to know to make the best decision based on your financial goals and personal situation.  

The Benefits of Refinancing Your Mortgage

Changing the loan term

If you’re having trouble affording your monthly payments, a refinance can help ease the pressure. By refinancing to a longer loan term, for example, from a 15-year mortgage to a 30-year mortgage, you can lower your monthly payment. However, switching to a longer loan term will result in you paying more in interest over the life of the loan. Conversely, shortening your loan term with a refinance may raise your monthly payment, but you’ll save on interest in the long run and build equity in your home faster. 

Lower interest rate

Although interest rates are no longer at the rock bottom levels seen during the middle of the pandemic, they’re still relatively low and likely to stay that way for the time being. Now is a great time to refinance if you can get a lower interest rate than your current rate. Keep in mind that closing costs and other fees may cut into your savings, so always run the numbers yourself to see if it’s actually a good deal. 

Switch to a fixed rate

If you have an adjustable-rate mortgage, you probably know it can be unstable and may cost you more if rates rise significantly. Switching from a variable to a low, fixed-rate mortgage can be a good way of eliminating the possibility your rates could go up and get you locked into a favorable rate now while the opportunity exists.

Pro Tip

Jill Schlesinger, CBS news analyst and author of “The Dumb Things Smart People Do With Their Money,” says when all is said and done, you will have to put in the work to make your refinance happen. If you’ve done your due diligence, though, a refinance can be your ticket to lower payments and increased financial stability, even in a time of economic turmoil.

The Drawbacks of Refinancing Your Mortgage

Closing costs

Yes, there are costs involved with refinancing, unfortunately. From lawyer fees to paying for an appraisal, you’ll probably end up putting in anywhere from $1,000 to $5,000 to refinance your loan. If you don’t have that kind of money on hand, you can often roll the closing costs into the mortgage itself, which will increase your loan value or interest rate but require less cash upfront.

If you are at risk of losing your income  

Even though economic recovery is on the horizon for the country as a whole, many families may still be struggling with financial uncertainty. If you think you’re at risk of losing your income or are in another financially unstable situation, it might be better to hold off on refinancing until you’re certain you’ll be able to afford it. 

If you are moving soon

If you are planning on moving in the next few years, a refinance is probably not your best option for saving money. You need to be in the home long enough to recoup the closing costs before you see the savings from refinancing, says Greg McBride, CFA, chief financial analyst for Bankrate.com. It may take years of lower payments to make back the amount you footed in closing costs. Refinancing is a long-term strategy, and its rewards are fully realized over years, not months. 

Other Options for Quick Cash Access

If your goal for refinancing is to reduce your monthly payment to have more cash on hand, here are some other options for quick cash access that don’t involve a mortgage refinance:

  • Home equity loan or home equity line of credit (HELOC). If you want to tap into your home equity without using a cash-out refinance, a home equity loan or HELOC may be a good choice. A home equity loan is a secured, fixed-rate installment loan that uses your house as collateral. A HELOC also uses your home as collateral, but it’s a line of revolving credit — similar to a credit card — rather than a lump-sum installment loan. With a HELOC, you can borrow as much as you need (up to the credit line) during the draw period and pay back the money with interest during the repayment period afterward.
  • Personal loan. A personal loan can provide quick cash for a variety of purposes, from debt consolidation to home improvements. Personal loans typically fall into two types: secured and unsecured. A secured loan requires you to put up an asset as collateral — like a car or house — which the lender can then take if you default on your loan. An unsecured loan doesn’t require any collateral. Secured loans typically offer lower interest rates, but they’re riskier for the borrower. The exact rate you’ll get for any personal loan depends on your credit score and the loan terms, so be sure to get quotes from multiple lenders to find the best rate. 
  • 0%-interest credit card. Some credit cards will offer a 0%-interest introductory period, usually between 15 and 20 months. If you take advantage of this, 0%-interest credit cards can potentially be used as an interest-free personal loan. But this strategy requires careful planning to make sure you pay off the entire balance before the intro period ends. Otherwise, you’ll be on the hook for high credit card APRs that could quickly land you in more debt. Also, keep in mind that credit cards with 0%-interest offers are typically only available to those with good or excellent credit.

Is Refinancing Right For Me?

There is no clear right or wrong answer for everyone to this question. Like any big financial decision, whether or not you should pursue a mortgage refinance depends a lot on your personal financial situation and goals. But rates are indeed low, and if your credit is reasonably good, your household has steady income, and you still owe a considerable amount on your current mortgage, then a refi is worth exploring. If you’re not sure, it costs nothing to call your local banker and ask for input to see whether you might benefit. 

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