Understanding the Advantages & Risks of Refinancing

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With a few exceptions, refinancing your mortgage has more benefits than risks. Whether you choose to go for lower monthly payments or the longer-term benefit of a shorter-length loan, the opportunity to refinance should offer you some financial relief. 

That doesn’t mean it’s a sure-fire win for everyone, though. If you are unemployed due to the pandemic, you’ll want to think carefully about whether it’s worth going through all the work of applying for a refinance if there’s a good chance you’ll be turned down. On the other hand, if you can show your job will return as the economy improves, you may find a lender willing to work with you. 

Refi Pros

Lower monthly payments 

If your income has been impacted, this may be your biggest reason for wanting a refinance. Lower monthly payments leave you with more cash in your pocket to pay other bills. You can increase the amount by considering lengthening the term of your mortgage, but keep in mind it will have you paying more interest in the long run. 

Shorten loan term

Switching from, say, a 30-year to a 15-year mortgage can save you significantly in the long term, though it may not be helpful in the short term if you need more cash for other purposes during the pandemic. You may find that with a reduced interest rate your mortgage payments don’t increase with the reduced term.

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.

Lower interest rate

Rates are historically low right now and are likely to stay for at least the next six months or so as the economy recovers from the damage brought by the COVID-19 pandemic. It’s impossible to predict whether the rates will go any lower, and experts suggest you not wait around hoping for a better rate, but take advantage of where the market is now if it makes sense for your refinance goals.

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.

Pay off mortgage faster

For many people, the pot of gold at the end of the rainbow is the day they get their mortgage paid off fully. If you can refinance now for a shorter term, great. If not, you can probably, depending on the terms of your mortgage, pay ahead on the principal, called mortgage amortization, which functionally shortens the mortgage.

Refi Cons 

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 coming up with that amount at once would be a hardship for you, you can often roll it into the mortgage itself, which will increase your payments slightly, but require less cash at the closing.

If you are at risk of losing your income  

Be careful if you are at risk of losing your income in the near future; loss of income could lead to an inability to pay your mortgage. Greg McBride, CFA, chief financial analyst for Bankrate.com, reminds us you need to be in the home long enough to recoup the closing costs before you see the savings from refinancing. If you refinance but then lose your home to foreclosure or relocate to secure employment, you could see a loss instead of savings. 

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. 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. 

Adding time to your loan

Experts we talked to were divided on whether it makes sense to restructure your loan with lower payments over a longer period of time. Some thought it was a good idea, but others think it’s stretching out the time it takes to be free of your loan. And because interest is compounding, even if you reduce your rate, it could cost you more long-term. 

The industry is inundated with volume 

Mortgage brokers and bankers are being hammered right now by homeowners looking to refinance. Plus, as parts of the country continue to observe stringent stay-at-home orders, many financial institutions are working with a skeleton staff working from home. All of this makes for a slower process. If you need a significant payoff for health care or other debts, a refinance is probably not going to happen quickly enough to help you, since the process can easily take several months.

Is Refinancing Right For Me?

There is no clear right or wrong answer for everyone to this question. But rates are indeed low, and if your credit is reasonably good, you and/or your partner are employed, 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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