While you can have lower rates, refinancing comes with big closing costs.
As a homeowner, what’s the best move to make once interest rates drop? One thing we’ve heard homeowners plan to do is refinance their homes.
Refinancing is a great idea at first because who wouldn’t want to lower their interest rate and reduce their monthly payments? But is this the right move for you? Let us give you some factors to consider together with the pros and cons of refinancing so you can make smart decisions about your home.
What are the main advantages of refinancing?
Aside from lower interest rates, here are three main benefits of refinancing that make it attractive to homeowners.
• Significant savings. If you refinance to a lower interest rate, you can cut your monthly mortgage payments. For many, that means saving hundreds each month over a 30-year mortgage, leading to tens of thousands in savings. It’s not just about lower payments; it also reduces the total interest you’ll pay over the life of the loan.
• Adjustable to fixed mortgage rates. Another advantage is switching from an adjustable-rate mortgage (ARM) to a fixed-rate mortgage. Fixed rates provide stability, especially if you plan to stay in your home long-term and want to avoid the unpredictability of rising interest rates.
• Shorter loan term. If you have a 30-year mortgage, you can switch to a 15-year mortgage. This could raise your monthly payments, but you’d pay off your loan in half the time and save a lot on interest. Plus, owning your home outright sooner gives you a sense of financial security and freedom.
“Refinancing could be a smart move if the interest rate difference is significant and you plan to stay in your home long-term.”
What are the main disadvantages of refinancing?
The benefits are clear, but before you pull the trigger, you should understand that there are other factors to consider besides getting a lower rate. Here are three downsides of refinancing you should be aware of.
• Closing costs. Just like your original mortgage, refinancing comes with closing costs, which can be 2% to 5% of the loan amount. For a $300,000 mortgage, that’s $6,000 to $15,000 upfront. That’s a big expense, especially if you don’t plan to stay in your home long.
Consider the break-even point: how long it will take to recover those costs with the savings from lower monthly payments. If you move or sell before then, you might not gain any real financial benefit from refinancing.
• It resets your loan term. If you’ve been paying on a 30-year mortgage for ten years and refinance into a new 30-year loan, you’re starting over. This can extend the time it takes to pay off your home and may even cost you more in interest over the life of the loan despite the lower rate.
• Impact on your credit score. Refinancing involves a hard inquiry on your credit report, which can result in a temporary dip in your credit score. This may not be a big deal if you have excellent credit, but if your score is borderline, it could affect your ability to get other loans or credit lines in the near future.
So, should you refinance when interest rates drop? It all depends on your situation. If the interest rate difference is big and you plan to stay in your home for a long time, then refinancing could be a smart move. But if the savings are minimal, and you’re planning on moving in the next few years, the costs and efforts of refinancing are not worth it.
Refinancing is not the only solution. Don’t forget that other strategies exist to save on your monthly mortgage. For example, making extra payments towards your principal can reduce the overall interest you pay and shorten the length of your loan. Or you could stick to your current loan terms and avoid extra costs associated with refinancing.
At the end of the day, your financial decisions should be based on your unique situation. What works for one person might not work for another, and that’s why it’s so important to do your homework, crunch the numbers, and talk to a trusted mortgage advisor or real estate agent who can help you navigate these decisions.
Tell us what you think. We’d love to hear from you, so feel free to contact us at (916) 547-3615 or paulboudier@KnowledgeRE.com.
