At some point, most homeowners will consider refinancing their mortgage. When you refinance, you get a new loan and use the proceeds to pay off the balance of your existing loan. There are many reasons to consider refinancing. Among them:
- To take advantage of lower interest rates, if rates have fallen since you got your original loan
- To move from an adjustable-rate mortgage to a fixed rate mortgage
- To take advantage of the equity built up in your home by borrowing additional amounts when refinancing
But before committing to refinancing your mortgage, it's important to understand the pros and cons.
The potential advantages to refinancing your mortgage include:
- Reducing your interest rate and lower monthly payments
- Shortening or lengthening the repayment time
- Taking cash out, which can then be used to spend, invest or pay other debts
- Consolidating several mortgages on the property into a single loan
- Avoiding the risk of rising interest rates if you move from an adjustable to fixed-rate mortgage
- Reducing or stopping private mortgage insurance (PMI) if your home has increased in value
- In some cases, you may be able to pay your home off more quickly than you would have under your original mortgage
The disadvantages to refinancing your mortgage include:
- Paying points, fees and closing costs can eat into any savings you'll gain by refinancing
- Paying penalties for paying off your existing mortgage
- Facing higher interest rates if you move from a fixed-rate mortgage to an adjustable rate mortgage
- Depending on the type of mortgage, you may ultimately pay more in interest than with your original mortgage
- Taking equity out of the house makes you owe more money
- Getting approved for a new mortgage may be difficult as banks tighten their lending requirements
- Taking cash out may decrease your equity in the home, triggering a lender's requirement that you carry PMI
- Depending on the term, or length, of your new loan, it may take much longer to pay off your home than it would have under your original loan
Get It in Writing
As part of the lending process, the lender is required to give you two documents that explain the details of your loan. These documents are called the Good Faith Estimate, which estimates the costs you'll pay at closing, and the Truth in Lending Statement, which details the loan's annual interest rate, total amount financed, the total amount you'll have paid on the loan after the life of the loan and a breakdown of your monthly payments. These disclosure documents will help you analyze the loan and compare loan features.
Do Your Homework
Before refinancing, you should take the time to carefully analyze how much money refinancing will cost you in the long run. Among the questions to consider:
- Will you lower your monthly payments and, if so, by how much?
- Will you have to pay an early-payment fee on your existing mortgage, and how much will that cost?
- If you're using cash from the mortgage to pay off other debts, how much will your total mortgage plus debt payments increase or decrease?
- How much will you pay out-of-pocket in points, fees, appraisal costs and other closing costs?
- Assuming you're refinancing to take advantage of a lower interest rate, how long will it take before the money you've saved in interest payments covers the cost of these refinance expenses?
- If the costs of refinancing are being rolled into the new mortgage, how much will you pay in interest on those expenses over the life of the loan?
- Taking into account all fees and expenses, will you save money over the life of the loan and, if so, how much?
- If you're taking cash out of your home's equity, what will the money be used for? Is it a good investment?
Questions for Your Attorney
Before refinancing your home, consider hiring an experienced real estate lawyer to help you review the loan documents and understand what you're signing.
Among the questions to consider asking your attorney:
- Do you have prior experience reviewing loan documents?
- Is there anything in the contract that could cause problems down the road?
- How much do you charge for your services?