Pros and Cons of Refinancing Your Mortgage in Today’s Economy
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A mortgage refinance gives you several options for tapping into home equity and adjusting your monthly budget. Homeowners can reduce their expenses by over $100 monthly or access thousands of dollars worth of home equity.
Refinancing a mortgage made more sense a few years ago when interest rates were as low as 3%. However, interest rates have soared since the pandemic, putting more doubt into a move that initially made more sense.
A mortgage refinance can still help your finances in today’s economy. However, each consumer has their own financial situation, and you should analyze those personal details before getting a refinance.
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What is a mortgage refinance?
A mortgage refinance involves replacing your current mortgage with a new mortgage. You will end up with different rates and terms for your property, and you cannot return to your original loan.
You can change the loan amount and the length of the new loan, but the interest rate always changes. You can go from a fixed-rate to an adjustable-rate mortgage while increasing the loan's repayment time.
The “no turning back” approach to mortgage refinances has made people cautious about getting them. Homeowners who bought or refinanced their properties a few years ago would have to give up their 3% interest rates. If you get a refinance now, you can be stuck with a 7% interest rate, and that’s if you have good credit.
When assessing your application, mortgage lenders will examine your credit score, debt-to-income ratio, and other details. These loan providers look at the same information as they would if you were buying a property. However, there is a key difference.
Your property’s LTV ratio cannot exceed the lender’s limit. The LTV ratio measures the percentage of your mortgage balance’s value relative to the property’s value. If you have a $1 million property and a $600,000 mortgage, you have a 60% LTV ratio.
Mortgage lenders will require that you pay for a home appraisal to determine the property’s current value, even if you do not want to do a cash-out refinance. Knowing your home’s current value helps lenders establish limits. If you have a $1 million home and a $600,000 mortgage, you cannot take out more than $200,000 from your property if your lender will not let you exceed an 80% LTV ratio. Some lenders are more generous with their LTV maximums.
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Pros and cons of refinancing your mortgage in today’s economy
A mortgage refinance can be a great decision, but the drawbacks are more apparent due to rising interest rates. Some pros and cons have changed as a response to the current economy.
However, other advantages and drawbacks have existed since financial institutions allowed consumers to refinance their mortgages. Before jumping into refinancing, consider these pros and drawbacks.
Pro #1: Access additional equity
A refinance lets you access the equity you have accumulated in your home. Property owners build home equity with each mortgage payment. Equity also accumulates as the property gains value. Investors who want to cash in on their elevated home values can use a cash-out refinance to borrow extra money.
Some people use the proceeds from a cash-out refinance to buy another property. It’s common for real estate investors to buy multiple properties and use their existing assets as leverage. This business model can work out if each property generates positive cash flow.
Others may have to initiate a cash-out refinance because they need the capital. Medical bills can get expensive and may require that you use your home equity to cover them. You may also want to invest in home improvements or go on an expensive vacation with your family.
Mortgage refinances give you the flexibility of extra capital. Home equity lines of credit and home equity loans are honorable mentions that can fulfill the same role.
Pro #2: Lower your monthly mortgage payments
One of the main draws of mortgage refinancing is reducing your monthly payments. Many people refinanced their homes before the pandemic to lock in lower rates. This option isn’t available in today’s economy, but you can still lower your monthly payments by extending your loan.
Turning a 5-year mortgage into a 10-year one spreads the monthly principal payments over time. If you have to pay a $100,000 balance in five years, it comes to $1,667/mo for a 5-year mortgage (excluding interest). That same payment drops to $833/mo if you switch to a 10-year term.
You can add more years to the life of the loan while taking out equity to potentially lower your monthly payments while accessing more cash. Some real estate investors frequently use refinancing to reduce monthly payments since many prioritize present cash flow.
A lower monthly payment can reduce your financial stress and free up space in your budget for other monthly purchases. A home is most people’s biggest expense, so this is the area to focus on if you want more flexibility in your budget. Saving money in smaller ways will also help, but your housing costs are a critical budget component.
Pro #3: Unsecured loans have higher rates
There’s been a lot of talk about how mortgage rates are at multi-decade highs. However, mortgages still offer some of the best rates available. You’ll have to contend with much higher interest rates if you take out an unsecured personal loan or rack up credit card debt. It’s possible to find financial products with 30% APR.
Seeing that mortgage interest rates can make homeowners more appreciative of current rates. Getting a refinance a few years ago was much better since mortgage rates are at historical highs. However, other financial products also have historically high interest rates and are far worse.
Therefore, a mortgage refinance is still a viable debt consolidation strategy. Do you have $50,000 in credit card debt with a 30% APR? You can pay it off with a refinance instead. Yes, you’ll contend with high mortgage rates, but those rates won’t be close to 30% APR.
Mortgages have lower rates than most financial products since they have collateral. Any loan secured with collateral will usually have a lower interest rate than an unsecured loan or line of credit.
Pro #4: Remove private mortgage insurance
You can stop paying private mortgage insurance on a traditional mortgage once you have 20% equity in your home. Putting extra capital into your loan can help you eliminate this additional cost.
It’s even worse for FHA loans. You’ll have to pay private mortgage insurance for these products for at least 11 years. Some FHA borrowers pay PMI for the duration of the loan. Refinancing into a conventional mortgage can eliminate the additional monthly expense.
You will have to contend with a higher interest rate, but it is possible to save money by getting rid of private mortgage insurance.
American Homeowners Could Save Big With The Help Of U.S. Mortgage Experts
If you've owned your home for 3+ years, you may be able to get cash out of your home and slash your monthly bills. It costs $0 to get connected with an expert and check your options. You'll be shocked to see how much you could save.
Con #1: Higher interest rates
This is the big elephant in the room. Many people will avoid refinancing right now because of higher interest rates. It is the biggest downside. Most homeowners have already locked in lower rates and don’t want to get stuck with today’s interest rates. That’s also why many homeowners stay put instead of moving. Higher interest rates do not incentivize people to leave their current homes.
Interest rates haven’t been this high since the 20th century. A higher interest rate will make it more difficult to pay off the principal due to each mortgage’s amortization schedule. Interest payments get front-loaded, and you only make meaningful payments toward the principal near the end of the loan’s term.
The higher interest rate can increase your monthly expenses by at least $100, but it may be more depending on the loan’s balance. Assume a homeowner has a $2,000 monthly principal payment of $24,000 annually. A 3% interest rate results in an additional $720 each year. However, an 8% interest rate adds an extra $1,920 per year to your housing costs.
The difference between a 3% and an 8% interest rate is an additional $1,200 per year. That’s also assuming your principal payment is $2,000/mo. Housing prices have been rising for several years, and you may have to contend with a mortgage payment ranging from $3,000 to $4,000 monthly. A few extra percentage points on your APR will make an even bigger difference in your total costs.
Con #2: Stay in debt longer
Higher interest rates are part of today’s economy, but this disadvantage lingers with mortgage refinances in any economy. It specifically applies to people using cash-out refinances or extending the duration of their loan.
Turning a 5-year original mortgage into a 10-year mortgage keeps you in debt for an additional five years. Interest will continue accumulating and increase your pay in the long run.
While it can be very convenient to tap into additional funds, cash-out refinances can allow people to keep their bad financial habits instead of making corrections. Receiving extra capital can encourage people to maintain their current lifestyles instead of making necessary cost cuts.
Just because you have equity in your home doesn’t mean you have to tap into it. Some homeowners prefer debt-free instead of having an extra $100,000 or more readily available. A home refinance may become necessary in certain scenarios, but some people can avoid it by trimming their expenses and actively pursuing opportunities to grow their income.
Con #3: Closing costs
Refinancing your mortgage isn’t free. You must pay various expenses like the origination fee and appraisal fee. However, these costs add up and are reflected in your closing costs.
Any mortgage's total cost equals a percentage of the mortgage’s balance. This balance ranges from 2% to 6% depending on the lender, credit score, debt-to-income ratio, and other factors.
If you get a cash-out refinance and end up with a $700,000 mortgage balance, your closing costs will likely range from $14,000 to $42,000. You can either pay those costs upfront or tack them to the backend of your mortgage.
Neither of these scenarios is ideal. Paying upfront reduces your available capital. If you put closing costs in your loan, you must keep your capital. However, you will end up paying more interest on your loan.
Con #4: Qualification requirements
Not everyone qualifies for a mortgage refinance. You need a FICO score of at least 620 to get a conventional refinance. FHA home loans have lower credit score requirements but are more expensive due to private mortgage insurance.
You will also have to fulfill your lender’s debt-to-income ratio. You cannot have a DTI ratio above 45% if you want a conventional mortgage. You can only reduce your DTI ratio by making more money and paying off your high-interest debt. If you do not qualify, you cannot refinance your property. Homeowners must contend with similar requirements for home equity loans and lines of credit.
Shopping around and comparing refinance rates can help you find better loan offers with more generous eligibility requirements. You can find viable ways to tap into your home equity even if you do not fulfill conventional requirements.
American Homeowners Could Save Big With The Help Of U.S. Mortgage Experts
If you've owned your home for 3+ years, you may be able to get cash out of your home and slash your monthly bills. It costs $0 to get connected with an expert and check your options. You'll be shocked to see how much you could save.
Mortgage refinancing lenders
Quicken Loans
Quicken Loans, one of the largest mortgage lenders in the U.S., specializes in streamlining the refinancing process to make it as convenient as possible for homeowners. They offer various refinancing options, including adjustable-rate mortgages, fixed-rate mortgages, and government-backed loans. Quicken Loans is known for its Rocket Mortgage platform, which allows customers to apply for refinancing online, providing fast loan decisions and personalized refinancing solutions based on the borrower's unique financial situation.
LowerMyBills
LowerMyBills is a part of the Experian family, focused on helping consumers compare various financial services, including mortgage refinancing options. They provide a platform where users can compare offers from multiple lenders to find the best rates and terms for their mortgage refinancing needs. LowerMyBills is particularly useful for those looking to reduce their monthly payments or tap into their home equity for large expenses, as it aggregates a wide range of offers, making it easier for homeowners to make informed decisions.
LendingTree
LendingTree is an online lending marketplace that connects borrowers with multiple lenders competing for their business. This model helps borrowers find the most competitive refinancing rates available. LendingTree offers a variety of refinancing options, including traditional mortgages, FHA loans, and VA loans. Their service is designed to provide quick and easy comparisons of multiple loan offers, enabling homeowners to choose the best deal based on their financial goals and current mortgage rates.
FAQs
Why should I refinance my mortgage?
People refinance their mortgages for several reasons, including lowering their interest rate, reducing their monthly payment, shortening their loan term, converting between adjustable-rate and fixed-rate mortgages, or tapping into home equity for large expenses.
When is the best time to refinance?
The best time to refinance depends on several factors, such as when you can secure a lower interest rate than your current rate, when your credit score has improved, or when home values have risen, increasing your home equity. Additionally, it's important to consider how long you plan to stay in your home to ensure the closing costs associated with refinancing are justified.
How does my credit score affect refinancing?
Your credit score is a critical factor in determining the interest rate and loan terms lenders will offer. A higher credit score can help you qualify for better rates, making refinancing more beneficial.
How much can I save by refinancing?
The amount you can save by refinancing depends on several factors, including the difference between your old and new interest rates, the terms of your new loan, and the associated refinancing costs. It's important to calculate your break-even point to determine how long it will take for the savings from a lower interest rate to surpass the refinancing costs.
Can I refinance with bad credit?
Refinancing with bad credit is possible, but you may face higher interest rates and less favorable terms. Some lenders specialize in loans for those with lower credit scores, and government-backed programs may offer more flexibility.
What is a cash-out refinance?
A cash-out refinance allows you to refinance your mortgage for more than you owe and take the difference in cash. This can be useful for consolidating high-interest debt, making home improvements, or covering other significant expenses.
Do I need an appraisal to refinance?
Most lenders require an appraisal as part of the refinancing process to determine your home's current market value. This ensures the loan amount does not exceed the value of the home.
How long does the refinancing process take?
The refinancing process typically takes between 30 to 45 days, but it can be faster or slower depending on the lender and your specific circumstances.
American Homeowners Could Save Big With The Help Of U.S. Mortgage Experts
If you've owned your home for 3+ years, you may be able to get cash out of your home and slash your monthly bills. It costs $0 to get connected with an expert and check your options. You'll be shocked to see how much you could save.
The bottom line
Refinancing your mortgage can still make sense in today’s economy. However, it made more sense a few years ago when interest rates were closer to 3%. Rates are rising for all financial products, not just mortgages. If you want to consolidate debt or borrow money at the lowest possible interest rate, a refinance can still be a great choice. In general, secured loans have lower interest rates than unsecured loans.
However, you don’t have to refinance a mortgage to tap into additional equity. You can take out a home equity loan with fixed monthly payments, or you can use a home equity line of credit. Both choices let you borrow capital without changing the rate and terms of your existing mortgage.
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Writer
Marc Guberti is a business freelance writer who specializes in personal finance, digital marketing, and entrepreneurship. His award-winning book "Content Marketing Secrets" teaches readers how to create, promote and optimize content for growth and revenue. Marc also hosts the "Breakthrough Success Podcast," where listeners learn how to master content marketing and get more clients.
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