With interest rates hitting record lows, you’ve likely heard that now is a good time to refinance. Although refinancing could be a good idea in some cases, it is important to understand why refinancing
is a bad idea for some.
Instead of highlighting only the positives of refinancing, we will also explore the drawbacks of refinancing. Here’s what you need to know before you decide to move forward with refinancing.
What is refinancing?
Refinancing a loan is when you take out a new loan to pay off an existing loan. The goal of refinancing is to secure a loan with better terms. Usually, this means the new loan has a lower interest rate or adjusted timeline to meet your financial goals.
For example, you might seek out a loan that has a lower interest rate to save money over the course of your loan. Or you might want to find a loan with a longer repayment term that comes with a lower monthly payment to allow more wiggle room in your budget.
Refinancing can also be used as a debt consolidation strategy. You combine multiple loans into one monthly payment with debt consolidation
You can refinance any kind of loan. But today, we will discuss the pros and cons of refinancing your mortgage.
How does refinancing work?
When you are considering refinancing, the first step is to shop around for the right lender. You’ll need to look for a lender that is able to offer better loan terms than your existing loan.
If you find a lender that offers more attractive loan terms, then you can apply for the loan. Once you are approved for the loan from the new lender, you’ll be able to pay off your existing loan in the closing process of the new loan. At that point, you’ll make debt payments to your new loan and your old loan will be completely paid off.
What is the downside of refinancing?
There are several downsides to refinancing. Here’s what you should be aware of:
Expensive closing costs
When you take out a new loan through the refinancing process, you’ll likely encounter closing costs of some kind. Although closing costs will vary based on the lender, these can range between 3% to 6% of the new loan amount.
Unfortunately, the closing costs of a new loan can easily amount to thousands of dollars. In some cases, the closing costs of refinancing could cancel out the potential savings of the refinanced terms. With that, it is critical that you consider the closing costs of refinancing before moving forward.
Potentially pay more in interest
Although many borrowers seeking a refinance will look for a lower interest rate, some may also seek a longer loan term. When you commit to a loan with a longer repayment term, it is possible that you’ll pay more in interest over the course of the loan.
A lower monthly payment might seem like a good idea, but it could cost you more in the long run.
Does refinancing hurt your credit?
When you take out a new loan, your credit score will usually dip a little bit. This is due to the fact that you’ve applied for a new line of credit and taken on more debt.
However, the exact impact to your credit score will depend on your unique situation. If you are using your credit responsibly, then refinancing may not dramatically hurt your credit score.
Related: Ways to Boost Your Credit Score
What is the benefit of refinancing?
The benefits of refinancing are more apparent than the downsides. Here are some positives to consider:
Lower interest rate
A lower interest rate on your debt could help you save thousands of dollars over the course of your loan. If you are stuck with a high interest rate on your current mortgage, then lower interest rates could be an appealing opportunity.
Lower your monthly payments
If your budget is stretched too thin by keeping up with your mortgage payments, then refinancing could be a helpful option. A lower interest rate or longer loan term could lead to a lower monthly payment. With that, you can free up some space in your budget.
Cash-out refinance opportunities
As a real estate investor, there are additional benefits of refinancing opportunities. You might have the ability to take money out of the property. With that, you have the potential to accelerate the growth of your real estate portfolio.
Learn more about the BRRRR strategy in my upcoming article!
One way that investors utilize cash-out refinance opportunities is through the BRRRR strategy. In this case, you would Buy Rehab, Rent, Refinance, and Repeat. The goal of the BRRRR strategy is to buy houses in need of repairs and rehabbing them to improve the value. Once you have renters in place, you can refinance the property and pull cash out of the equity to finance the down payment of your next deal.
Should I refinance my mortgage?
The answer to whether or not you should refinance your mortgage will come down to the details of your particular situation. If you are considering refinancing your mortgage, it can be difficult to weigh the pros and cons. But the biggest factor to weigh is the costs.
Take the time to consider your potential savings against the closing costs of a refinance. Don’t dive into a refinancing process chasing lower interest rates without determining the cost of the refinance beforehand. In many cases, you’ll find that the cost of refinancing outweighs the opportunity to save with lower interest rates.
You should not move forward with a refinance if you are unable to save money overall. But make sure to run the numbers ahead of time to save yourself time and money.
The bottom line
Refinancing a mortgage can be a good idea for some borrowers. If you are able to save money through the refinancing process, even with closing costs, then refinancing is a good option.
But if you aren’t able to come out ahead with closing costs involved, then refinancing is a bad idea. Don’t chase low interest rates through refinancing without considering the costs involved.
Take the time to learn more about real estate investing in our full guide to start investing in real estate