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Pros & Cons of Refinancing Your Home Mortgage Loan

If you purchased your home when the federal funds rate was at least 150 basis points — 1.5% — higher than today, an opportunity to profit from low interest rates is staring you in the face.

In fact, there’s a good chance it’s surrounding you as you read these words.

Like millions of other homeowners paying more than necessary each month, you can take advantage of current low interest rates by refinancing your mortgage loan.

Knowing whether you should refinance your mortgage is trickier. Before you can decide, you need to know more about its upsides and downsides, including the potentially negative consequences for your personal finances and housing security.

Pro tip: If you decide that refinancing is the best option for you, Credible will allow you to compare prequalified rates from multiple lenders in just minutes.

Advantages of Refinancing Your Mortgage Loan

Refinancing your mortgage loan could give you a financial boost in several ways. Many refinancing applicants realize more than one of these benefits.

1. It Could Reduce Your Lifetime Interest Costs

Reducing lifetime interest costs — and your total borrowing costs along with them — is among the most compelling reasons to refinance a mortgage. Many homeowners refinance with this objective in mind.

Depending on the structure, type, term, and rate of your original loan, refinancing your mortgage could reduce your total interest expense in one or more ways:

  • Lowering the Interest Rate. Getting a lower interest rate is much more likely to occur if rates have fallen since your original loan’s issue and critical elements of your borrower profile — such as your credit score, income, and debt-to-income ratio — remain constant or improve.
  • Shortening the Term. A shorter term means less time for interest to accrue. The downside is the potential for a higher monthly payment.
  • Converting From Adjustable Rate to Fixed Rate. Refinancing your adjustable-rate loan into a fixed-rate loan eliminates the risk your interest rate will spike if prevailing rates rise.
  • Converting From Jumbo to Conventional. Jumbo loans generally carry higher interest rates than conforming (conventional) loans. Once your remaining balance drops below the conforming loan limit (about $485,000 in most markets), refinancing could reduce your lifetime borrowing costs.

2. It Could Lower Your Monthly Payments

Simply refinancing a higher-rate loan into a lower-rate loan with an equivalent term is likely to lower your monthly payments. If a lower rate isn’t in the cards, a less desirable alternative is to refinance into a longer-term loan and spread your payments over a longer timeframe. The downside of this move is a higher lifetime borrowing cost.

3. It Could Increase Your Loan’s Predictability

Predictability isn’t a concern if your original loan has a fixed rate. You experience year-to-year variation on the escrow side, as your property taxes and insurance fluctuate. But your principal and interest payment remain fixed for the life of the loan.

But if your original loan has an adjustable rate, predictability is a problem, and refinancing to a fixed-rate loan is a reasonable solution. If your new fixed-rate loan prevents a costly upward rate adjustment, all the better.

4. It Could Eliminate Mortgage Insurance

The FHA mortgage loan program has helped millions of first-time homebuyers afford places of their own. Maybe you’re among them. If so, you know that your FHA loan carries a hefty cost: high annual mortgage insurance premiums that remain in force for at least 11 years from the issue date (on loans issued after June 2013) — and permanently, in some cases.

Refinancing your FHA loan into a conventional loan could eliminate its annual mortgage insurance premium years ahead of schedule. You need only wait to accumulate 20% equity in your home, which should happen much sooner than 11 years (and certainly sooner than 15 or 30 years) after your original loan’s issue.

5. It’s a Low-Cost Way to Tap the Equity in Your Home

If you plan to refinance anyway to take advantage of low interest rates, a cash-out refinance loan is a fine alternative to a home equity loan or line of credit. Like those home equity products, a cash-out refinance loan is secured by the value of the home itself, reducing risk for the lender and facilitating rates far lower than credit cards and unsecured personal loans. You can use this low-cost capital for basically anything:

  • Consolidating higher-interest debt
  • Financing major home improvements or repairs
  • Paying your kids’ college bills
  • Paying off your student loans
  • Settling medical bills and other major expenses

Disadvantages of Refinancing Your Mortgage Loan

Refinancing your mortgage is not a risk- or hassle-free endeavor. Potential drawbacks include an arduous application process, no guarantee of approval or cost savings, the potential for a higher monthly payment, and the risk — heightened in down markets — that the required lender appraisal could actually backfire.

1. The Application Process Is a Pain

Applying to refinance your mortgage isn’t quite as involved or time-consuming as applying for a purchase loan. But it’s not a walk in the park or something to do on a whim. As you did before your purchase loan, you must provide reams of documentation verifying your employment, income, and identity. And the deal won’t be done until you close, leaving you on pins and needles for weeks. Don’t go through with it unless you’re serious about refinancing.

2. Approval Is Not Guaranteed

The fact that you own your home doesn’t entitle you to refinance its mortgage. If your borrower profile has deteriorated due to a drop in your credit score or income, a recent job change, or a higher debt-to-income ratio, your application could be denied outright or accepted on less favorable terms than expected.

3. You’re Not Guaranteed to Break Even

Most refinancing applicants expect their new loans to cost less than their original loans. But there are plenty of scenarios in which that doesn’t pan out — and not just because the borrower intentionally refinances into a longer term or can’t find a lower rate. If fate intervenes and you must sell your house before you break even on your refinance loan, you’ll never recoup your loan’s upfront costs.

4. Your Monthly Payment Could Increase

If your objective is to cash out some of your home’s equity or shorten your loan term, your monthly payment will probably increase. Nevertheless, the jump might come as a shock and can put severe strain on your monthly budget over time. Before taking out a loan that costs more than your current housing payment, be as sure as you can that it will remain affordable.

5. It Could Backfire in a Down Market

If home values in your area have declined since you purchased or last ordered a professional appraisal on your home, you run the risk of a lowball appraisal that squelches your chance of qualifying for a refinance loan anytime soon. This outcome is likelier in areas with high (or increasing) rates of foreclosures and short sales. If you suspect an appraisal would do more harm than good and don’t urgently need to refinance, wait until the market improves.

Final Word

Refinancing a mortgage is not something to be done on a whim. Even when interest rates are low and your borrower profile is strong, the undertaking is no sure thing.

A forced relocation could compel you to sell your house years before you planned, wiping out most of your loan’s expected savings and causing you to lose money on the deal. An unexpected job loss could threaten your family’s financial stability and put you at risk of losing your home. A market downturn could leave you with less equity than you expected, putting your home improvement plans on hold.

Then again, you could see your refinance application approved without a hitch, reap thousands upon thousands of dollars in savings thanks to a lower monthly payment, and avoid the downsides of the nonconventional loan that had outlived its purpose the day you first closed on your home.

There’s simply no way to predict what will happen. But as is always the case when the stakes are high, fortune favors those who know what could go wrong — and what could go right.

Are you considering refinancing your mortgage? If you’re hesitant, what’s holding you back?

Brian Martucci
Brian Martucci writes about credit cards, banking, insurance, travel, and more. When he's not investigating time- and money-saving strategies for Money Crashers readers, you can find him exploring his favorite trails or sampling a new cuisine. Reach him on Twitter @Brian_Martucci.

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