There are many good reasons to refinance a home, such as lowering your monthly payments, paying off the home faster, or rebalancing your financial situation. But that doesn’t mean that refinancing is always the best option for a homeowner. Depending on your current financial position and your long-term goals, it could be better to sell your home, get a home equity line of credit, or take other significant action.
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What Is Refinancing?
In case you aren’t familiar, refinancing is a financial tool that allows you to restructure your home loan. With the help of a lender, you’ll pay off your existing mortgage and replace it with a new mortgage, typically with a new interest rate and new terms.
It’s a move that can improve your financial position if you time it and plan it correctly, but as we’ll see, it’s not universally or unimpeachably valuable.
Why Refinance?
These are some of the biggest reasons why people refinance their mortgage:
- Lower monthly payments. The biggest and most obvious reason is to lower your monthly mortgage payments – and there are actually a few different ways this can happen. For example, you could take on a loan with a lower interest rate, which reduces the amount of money you’ll pay on a monthly basis and reduces the total amount you’ll owe over the course of the loan. You could also change your terms from 15-year to 30-year, giving you more time to pay off the debt and reducing your monthly payments as well.
- A fixed rate loan. Variable rate mortgages often seem attractive because they may start with an interest rate lower than their fixed counterparts. But there’s a catch – that rate may rise if conditions change in the future. If this happens to you, or if you’ve come to realize the drawbacks of a variable rate loan, you might want to refinance to capitalize on a fixed rate loan.
- Faster loan payoff. If you want to retire soon or if you just want to pay less total interest to the bank, you may be interested in paying off your loan as quickly as possible. That could mean reducing the terms of your loan from 30-year to 15-year with refinancing; you’ll face higher monthly payments in the short term, but your home will be paid off quicker in the long term.
- Debt rebalancing. Sometimes, people refinance as a way to rebalance their assets and debts. For example, they may take out a bigger home loan to tap into their existing home equity and pay off credit card debt, which has a higher interest rate.
The Drawbacks of Refinancing
Of course, there are a few drawbacks associated with refinancing.
- Loan closing fees. Depending on where and how you refinance, you may be responsible for paying some upfront fees. If you’re tapping into your home equity, you can get the cash to cover this, but it can still hit you hard.
- Potential savings. Not everyone is going to save money by refinancing. If you currently have a fixed rate mortgage with a low interest rate, refinancing could actually leave you with higher monthly mortgage payments. Sometimes, the move just doesn’t make sense.
- Terms and conditions. There may be other terms and conditions that affect the mortgage in some way, muting its benefits and introducing other disadvantages.
- Time and effort. Don’t forget that it takes time and effort to refinance. You’ll need to compare different providers, gather the requisite paperwork, and jump through some hoops before it’s a totally done deal. Though if you’re going to save thousands of dollars, this may be well worth it.
Alternatives to Refinancing
So if refinancing isn’t the right move, and you’re in a financially unfavorable position, what are the alternatives?
- Selling your home. First, you could simply sell your home. Whether you list it on the market or sell it directly to a buyer, you’ll get an immediate injection of capital – and hopefully, be able to pay off your loan with some money left over.
- A home equity line of credit. A home equity line of credit is a loan where your home serves as collateral. You can borrow a fixed amount of money due to your home’s existing equity and use that money however you see fit.
- Improving your financial position. If you’re financially struggling, this is a good chance to review and improve your financial position. For example, can you increase your credit score? Can you change careers to make more money? Can you eliminate expenses so you can pay off your debts?
Refinancing does have the power to help you improve your finances – especially if you’re currently locked into an unfavorable mortgage. But you need to consider your options carefully before making a final decision.