With interest rates dropping, refinancing your home will naturally get more popular. Refinancing your home is an easy way to save money. However, it is not without its potential downsides.
Here are four potential downsides to keep in mind if you are thinking about refinancing your home.
1. Closing Costs
Refinancing is not free aqua. There are typically closing costs between 3–6%. It is important to make sure that refinancing saves you enough money to cover these costs.
Make sure you comparison shop. Different banks will offer different rates. There is also an option to refinance with no closing costs. However, if you go the no closing cost route, it will come with a slightly higher interest rate.
2. Longer Loan Term
15 and 30-year terms are most common when refinancing. Depending on how many years you have left on your mortgage, refinancing could extend your payoff date.
This is not a negative for everyone, but it is to some people. Some people like the financial security that comes with having a paid-off home. Sometimes refinancing can push that security farther into the future.
3. More Expensive to Move
If you are not sure how long you will remain in your home, be careful. A lower rate doesn’t always save you money. If you plan to move in the next few years, refinancing might not make sense for you. Refinancing will only save you money if you stay in your home long enough to recoup the closing coats.
Figure out how much your refinanced rate will save you per month. Then, divide your closing costs by your monthly savings. That tells you how many months you need to stay in your home to make refinancing profitable.
4. Equity Reduction
The equity you have in your house is the home’s value minus how much you owe on the home. The more equity you have, the more money you will pocket when you sell your home.
If you are disciplined with your money, less home equity is not a problem. However, if you are an undisciplined spender, it can be a recipe for trouble. Having money tied up in your home is a great form of forced savings. There is no risk of wasting that money on impulsive decisions.
Upsides of Refinancing
Despite the potential drawbacks, refinancing your home is usually a good idea. Here are five of the upsides that come with refinancing your home.
1. Take Cash Out
When you refinance, you have the option to take cash out. You can then spend that money however you want. Three common uses of that money are:
- Home Improvements
- Consolidate Debt
- Real Estate Investments
Those are the most common uses. However, the possibilities are endless.
2. Lower Monthly Payment
A lower interest rate leads to lower monthly payments. You can then use that extra month every month on whatever you want.
3. Consolidate Debt
Debt is widespread in America today, but not all debt is created equal. Most debt carries a higher interest rate than mortgages.
- Credit Cards
- Car Loans
- Student Loans
You can use a cash-out refinance to pay off debt. That will save you lots of money on interest, allowing you to get out of debt faster.
4. Shorter Term
It is possible to refinance into a shorter term. This will usually raise your monthly payment but lead to a sooner payoff date.
If you can handle the higher monthly payment, this is a good option. It brings you close to owning your home free and clear.
5. Eliminate PMI
Private Mortgage Insurance is required when you make a downpayment of less than 20%. PMI typically costs between 0.5% and 1% annually.
That is money down the drain every month. There is no reason to carry PMI longer than absolutely necessary.
If the equity in your home is greater than 20% of your home’s value, you are eligible to get rid of your PMI when refinancing.
When it comes to refinancing your home, the positives definitely outweigh the negatives. However, there are some potential negatives that you should keep in mind so that you can make an informed decision.