Refinancing a mortgage loan often makes a lot of financial sense — especially when mortgage refinance rates are very low.
The refinancing process involves taking out a new home loan that’s used to repay your existing mortgage debt. If your new loan has a lower rate than your current mortgage, you should be able to reduce your repayment costs and thus pay off your loan more easily.
If you find loan rates that are well below what you currently pay, you may be excited to refinance. However, you need to consider the downsides before you move forward.
Here are two of the biggest disadvantages of refinancing:
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1. You could reset your payment timeline
Most people don’t refinance straight after they take out a home loan. You’re more likely to pay down your mortgage for a while before you discover you can reduce your interest rate by refinancing.
When you refinance, you’ll have to select a new loan term. And many people default to a 30-year mortgage for a combination of these reasons:
- It’s what they had before
- It’s common and offered by many lenders
- It often lowers monthly payments more than other refinance loans
Let’s say you already have a 30-year loan which you’ve been paying down for a while. If you take out another one with the same term, you’ll reset the clock. You may have had only 25 or 26 years left to pay your current loan. Instead, you’ll start over and have 30 more years of payments to make.
This delays the time until you are debt free. It also cuts into any savings you’d make by reducing your interest rate since you’ll pay interest for longer. In fact, depending on just how much you increase your payoff time, you could end up paying more in total interest even if you drop your rate.
2. You will have to cover closing costs
Refinancing costs money. In fact, chances are good you’ll have to pay thousands of dollars in closing costs including a loan origination fee, an appraisal, and title insurance.
If you save money on your monthly payments and interest costs, you can eventually cover those closing costs. But not everyone does because many homeowners move shortly after refinancing, or they refinance again before they’ve broken even.
Be sure to consider how long it will take to cover your closing costs. You can calculate this by dividing the costs by your monthly savings. For example, if you spend $6,000 in closing and save $200 per month, it would take you 30 months, or 2.5 years to break even. If you don’t plan to keep your new loan long enough to cover your closing costs, it’s probably not a good idea to refinance.
You can avoid the first downside by choosing a shorter payoff time or the same payoff time as your existing loan. But there’s no avoiding closing costs, so be sure that these upfront fees are worth paying before you act.
View more information: https://www.fool.com/the-ascent/mortgages/articles/2-downsides-of-refinancing-your-mortgage/