Refinancing

March 5, 2024

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What Does it Mean to Refinance?

The term ‘refinance’ is commonly brought up in discussions on loans, but what does it truly mean? In the case of a mortgage, refinancing involves replacing a current mortgage with a new one, as the lender of the new mortgage pays off the old mortgage. This results in a new loan with a different principal amount and interest rate than the previous one.

Similar to the mortgage you agree to when you buy a home, refinancing requires you to fill out an application and go through the underwriting and closing process. As a result, there are costs associated with refinancing, which will be highlighted at the end of the blog post.

Common Reasons for Refinancing

There are several reasons to refinance, and many of them involve saving money – whether that is in the form of a lower interest rate or lower monthly payment. However, that is not always the primary goal of those who choose to refinance. Common reasons include:

• Lower the interest rate.
• Decrease the monthly payment.
• Pay off the loan sooner.
• Extend the repayment term.
• Access equity with a cash-out refinance.
• Eliminate FHA mortgage insurance.
• Switch from an adjustable-rate loan to one with a fixed rate.
• Improved credit may provide access to more favorable terms.

While paying off the loan sooner will likely save you money in the long term, the same cannot necessarily be said of extending the repayment term. Although extending the term typically allows for a lower monthly payment, it also increases the amount of time you will be paying interest on the loan.

Pros and Cons of Refinancing

The advantages of refinancing typically outweigh the disadvantages, but it is helpful to know both the potential pros and cons before choosing to refinance. Timing is one of the most important factors when determining whether to refinance or not, and hindsight is much clearer than the present when it comes to timing a refinance just right. The pros listed below reflect the potential benefits of refinancing but are not a guarantee for everyone who attempts to refinance. Additionally, the disadvantages vary from case to case, and those mentioned are not applicable in every situation.

Pros

• Lower your monthly payment and/or interest rate.
• Gain predictability and possible savings by converting to a fixed-rate term.
• Access much-needed funds with a cash-out refinance.
• Save on interest by switching to a shorter loan term.

Cons

• Costs associated with refinancing.
• Total interest owed over the life of the loan could increase if you reset to the original length (Example: 30 years).
• If you switch to a fixed-rate mortgage and rates drop, you are locked in at that rate unless you refinance again.
• The equity you have in your home could change.

The Cost of Refinancing

Refinancing fees and closing costs are similar to what you would expect to pay when acquiring a mortgage to purchase a home. In most cases, it costs 3% to 6% of your outstanding principal balance to refinance. For example, if you still owe $300,000 on your home, refinance fees would cost between $9,000 and $18,000. Keep this in mind as you think through the costs you will save in the long run by refinancing.

Common fees associated with refinancing include:

• Government recording costs.
• Appraisal fees.
• Credit report fees.
• Lender origination fees.
• Title services.
• Tax service fees.
• Survey fees.
• Attorney fees.
• Underwriting fees.

While it can certainly be costly in the short term to refinance, it is often worth it in the long run depending on how long you plan to stay in your home.