What Are the Risks of Refinancing Your Mortgage?

Jun 13, 2023 | Mortgage Guides

Refinancing Risks: What You Need to Know Before Making a Move

For many homeowners, mortgage refinancing can be an attractive option. It could save money on your payments, but being aware of the risks involved is essential. This article will provide the information you need to make an informed decision on a mortgage refinance. 

What Is a Refinance?

When you refinance, you take out a new loan to pay off the old one. Refinancing can be done for various reasons, such as getting a lower interest rate, shortening the loan length, or consolidating debt. In fact, over 70% of homeowners who refinance do so to lower their payments.

There are a few things to keep in mind when considering a refinance. First, make sure that you can qualify for a new loan. That depends on your credit score, income, and other factors. Second, compare the new loan’s terms to the old loan to ensure it is prudent. Last, be sure to factor in the closing costs.

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Types of Refinancing

Cash-Out Refinancing 

When you borrow more money than you owe on a mortgage, use the cash for home improvements, debt consolidation, or education expenses. A cash-out refinance can be a good option if you need money for a large purchase and have equity. However, you will pay interest on the money borrowed, so make sure you can afford the payments.

Rate and Term Refinancing 

When you refinance a mortgage for a lower interest rate or a longer loan term. A rate and term refinance can be a good option if the interest rate has increased since you took out the original mortgage or you want to get lower payments. However, you will pay interest for a longer time and, therefore, will pay more over the life of the loan.

Streamline Refinancing 

A government-backed refinancing program that is available to homeowners who meet specific eligibility requirements. Streamline refinancing is more straightforward and faster than traditional refinancing, with no closing costs or appraisal fees.

Cost of Refinancing

The cost depends on several factors, including the type of loan, the amount, the interest rate, and the fees associated with the refinance.

In general, costs can be divided into two categories: closing costs and origination fees. The lender charges closing costs, including appraisal fees, title insurance, and recording fees. These costs average 2 to 5 percent of the loan. Origination fees cover the processing of your loan application. 

The cost of refinancing can be significant. However, you can save money if you qualify for a lower interest rate.

Money-Saving Tips

  • Shop around for the best interest rate.
  • Compare the fees charged by lenders.
  • Consider refinancing to a shorter-term loan to save on interest.
  • Make sure you can afford the payments.

Refinancing can be complex, so work with a qualified mortgage professional to understand your options and the potential costs.

Qualifying for Refinancing

  • Have good credit: Your credit score will be the most critical factor determining the interest rate.
  • Have a low debt-to-income ratio: The debt-to-income ratio is the debt you owe compared to your income. A lower debt-to-income ratio makes you a more attractive borrower.
  • Have a stable income: Lenders want to see that you have an income that allows you to make the payments.
  • Have enough equity: Equity is the difference between the value of your home and the amount you owe. You must have at least 20 percent equity to qualify for a conventional refinance.

Pros and Cons of a Mortgage Refinance

Benefits of Refinancing

  • Lower interest rates: If interest rates have decreased since you took out your original loan, you might get a lower interest rate. That could save you money on your monthly payments.
  • Longer loan terms: You might get a longer loan term, which could lower your payments. However, you will pay more interest over the life of the loan.
  • Consolidate debt: If you have multiple high-interest loans, you can refinance them into one lower-interest loan. That can simplify your finances.
  • Get cash out: In some cases, you may be able to borrow money from your home. That money can be used for home improvements, debt consolidation, or education expenses.

Risks of Refinancing

  • You could have a higher interest rate because the interest rate on a refinanced mortgage is based on current market rates, which can fluctuate.
  • You might pay closing costs: Closing costs include origination fees, appraisal fees, and title insurance.
  • You could shorten the loan’s term: You will have higher monthly payments, but you will be able to pay off the loan sooner. 
  • You could lose your home if you default: This is serious, so only refinance if you are confident you can make the new payments.

Alternatives to Refinancing

There are other options to lower your mortgage or reduce the interest. For instance, you could renegotiate the terms of your mortgage with your creditor. That could involve extending the length of the loan or switching to a fixed-rate mortgage. Another strategy is making extra payments toward the principal, which can shorten the loan’s length. In addition, you could explore government-backed loan modification programs or seek advice from a housing counselor.

Nonetheless, if you choose to continue refinancing, ensure you are aware of how to avoid common mortgage refinancing mistakes.

Conclusion

In conclusion, while mortgage refinancing can provide many benefits, there are also risks. It is important to weigh the potential savings against a new loan’s costs and long-term implications. Homeowners should also be wary of lenders offering incredible “deals” and research all possible refinancing options. By considering the risks and benefits, you can make an informed decision about whether or not to refinance your mortgage.

Learn more about refinancing and other home ownership options at Wesley Mortgage, the official mortgage provider of the Tennessee Titans. Click the link below to get started and speak with one of our loan officers.

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