The real estate market is a huge player in the nation’s economy, which means that a lot of money funnels through it to individuals, businesses, and corporations. To help maintain this success, advertisements beckon you to buy a new home, take out a new loan, refinance the existing home, etc., this isn’t necessarily a bad thing. We all benefit from an economy that is flowing in as well as out. But the question is, should you listen to those advertisements and get a refinance? Is it worth it? They claim it will save you money, so will it? There is good and bad to a refinance, as there are with any major financial decision, and after learning a bit about the good and the bad, you’ll be better equipped to make the successful choice.
Why You May Want to Refinance
When you refinance a home you take out a new loan on an existing property. This new loan pays off the old loan and you are left with different terms. When you take out a new loan the power goes back into your hands to some degree, meaning you can adjust the terms you are dealing with rather than being stuck in the terms you already have. For example, your original loan has an interest rate of 5.5% and a 30-year-loan term. That’s not bad, but the current rate you can qualify for is 4.5% and you know you can afford a shorter loan term. But you’re stuck with the original loan. That’s where a refinance comes in.
When the interest rates drop, many homeowners are able to qualify for rates lower than the one they were originally given. They can also reduce the length of the loan term – or increase it if they’d like and they can often reduce monthly mortgage payments. This is the biggest reason people refinance. It gives them a chance to make changes to a loan that they weren’t able to secure previously. And, when these changes are done correctly, the homeowner can and typically will save money over the life of the loan. So the question you need to ask yourself is not whether you should refinance, but whether the refinance will benefit you financially. Will your interest rate drop, will your mortgage payment drop, and will you save money over time? If you’re not sure, start playing around on a refinance calculator to see if the financial benefit will be worth it.
Fees and Closing Costs – The Downside of the Refinance
While refinancing has the potential to save you money, the downside of the refinance can and often does reduce that potential. When you refinance into a loan, you don’t just go to a new lender and sign different papers. You have to go through the entire loan process again, involving underwriters, credit reporting bureaus, title companies, appraiser, inspectors, and anybody else your lender may need to get the job done. All of these people require their slice of the pie, so somebody is going to have to pay the fees for the services. That somebody is typically the homeowner. Now, oftentimes you can get a no cost refinance and have the lender pay the closing costs (which are usually in the thousands) but typically when this is done you get a higher interest rate and the closing costs are often rolled into the loan, so your loan amount increases. Most of the time the no cost option is just a way to defer the payment.
In addition to the closing costs, you also have the fact that the amortization schedule starts over. The amortization schedule shows how much you are paying in interest every month and how much is going to principle. For the first few years of a home loan, most of the monthly payment is going to interest. When this starts over, you’re back to paying more in interest. If you’ve only had the loan for a couple of years, this isn’t going to be hugely impactful, but if you have had it for a good ten years, you’ll feel the impact more.
The closing costs, the time it takes to get the refinance done, and the potential for loss through the amortizing interest are all reasons you need to take a second look at that refinance. They aren’t reasons that say you shouldn’t refinance, just things you need to be aware of before you go into it. What your job is as the homeowner is to make sure the refinance will pay off for you financially.