Pros and Cons of Mortgage Refinancing
You find out that mortgage interest rates are pretty low, but you’ve committed to a fixed rate mortgage. With that in mind, the question of whether or not you should refinance your mortgage comes up. Refinancing a mortgage means that you get a new mortgage – you finance it again, with an altered payment plan.
Here are the basics of how a mortgage works. When you make a payment, some percentage of that payment will go towards your interest. The rest of the payment will go towards your original loan principal. The more your payment will apply to your principal, the better, because you will be paying off the loan faster. The further along you progress in the mortgage, the more payments will apply to your original loan principal.
Here are the pros and cons of mortgage refinancing.
Pros
- Like the scenario mentioned above, many people with fixed-rate mortgages that refinance are motivated by the opportunity to get a lower interest rate.
- If you refinance and get a lower interest rate, you will be saving a lot of money. Even small differences in interest rate can make a big difference.
- If you refinance, you get the opportunity to lower your interest rate and save thousands of dollars off your total loan payment.
- You can cash out your equity (the difference between your house’s worth and what you owe the mortgage lender). You borrow against your equity and refinance for more than your house’s current principal balance. This cash can be used to pay off any debt, make home improvements, start a business, pay your children’s tuition etc.
Cons
- If you refinance, it will re-start the mortgage clock and bring your amortization schedule back to square one. When you start a new mortgage, the majority of your payment will apply to your interest, and a small amount to your original loan principal. This will be evident when at the end of your first year of mortgage payment; you’ll find that you hardly made a dent in the principal balance.
- When you reset the clock back to year one, you will have to pay mostly interest. This might not be bad if you are only a few years into your current mortgage. However, if you’re further along in the mortgage, it might be good to calculate and see whether the lower interest rate is worth resetting the mortgage back to the first year.
The bottom line is that don’t assume that refinancing is a good idea or a bad idea. Gather the right numbers for your interest rate, loan terms and closing costs onto a spreadsheet or an online refinance calculator to find out if this is a worthwhile change.
A general rule of thumb is that, the earlier you are in your mortgage that you want to refinance, the better. At Collin Bruce, our mortgage advisors are experts in all things refinancing.
