Refinancing Your Mortgage: Pros And Cons

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To begin with, what does it all mean? Refinancing a mortgage means paying off an existing loan and replacing it with a new one.

There are many reasons why homeowners refinance:

1) to obtain a lower interest rate

2) to shorten the term of their mortgage

3) to convert from a variable-rate mortgage to a fixed-rate mortgage (or vice versa)

4) to tap into home equity to finance a large purchase

5) to consolidate debt.

Let’s start on the negative side… what is not so great about refinancing a mortgage?

The cost!

The number one downside is that it costs money. What you’re doing is taking out a new mortgage to pay off the old one – so you’ll have to pay most of the same closing costs you did when you first bought the home, including origination fees, title insurance, application fees and closing fees.

To make things more difficult these days, you’ll likely have to pay for a new appraisal as well, since most homes have declined in value over the past few years and the new lender will be unwilling to loan you more than the property is worth – they would rather leave that burden on your current lender!

Refinancing will also cost you from 2-6 % of the amount borrowed, depending on where you live, though most borrowers tend to pay toward the lower end of that range. The key then, is to make sure you’re saving enough by refinancing to make the transaction worthwhile. Speaking of which…

2. Saving!

You only know if you’re saving enough by refinancing if you can recover your closing costs in a reasonable time. If your new mortgage rate is only half a percentage point lower than the old one, it might take 7-10 years to recoup the costs of refinancing. The general rule of thumb is that you want to save a full percent or more to make refinancing worthwhile, depending on how much your closing costs were.

The way to tell if you’re saving enough is by calculating your “break-even point” . You can use a refinance break-even calculator to determine how long this would be.

You generally want to be able to recoup your costs within five years. Many homeowners move homes after 5-7 years, so if you move before you reach the break-even point, you won’t recover your refinance costs. If you expect to stay in the home for a long time, you can allow more time to reach your break-even point.

What about… the positive reasons!?

Your fixed mortgage rate

The fixed mortgage rate your obtained years ago might be higher than the one today. You can refinance your mortgage to obtain a lower interest rate by switching from a variable rate mortgage to a fixed rate mortgage, like mentioned at the beginning of the blog.

Perhaps when you first obtained your mortgage, you weren’t sure which one would be right for you. There is the temptation of a low interest rate of the variable-rate mortgage, but fluctuations have caused it to rise to an undesirable rate. You can always switch to a more “secure” fixed rate mortgage and save money.

2. Debt consolidation

You can benefit from lower interest rates and the simplicity of having all of your debt in one place. Consolidating your mortgages into one could be the best mortgage solution for your situation. You would receive a longer repayment duration and a fixed monthly interest rate.

3. Paying off other debts or planning ahead

You may have debts you or your children incurred from university/college tuitions. You might be planning for a wedding and starting a family. You will most probably like the security of having a cash provision for emergency situations. By using the equity in your home, you can have an interesting solution. Since a mortgage is a secured loan, the interest rate is much lower than an unsecured loan.