With some of the lowest recorded mortgage interest
ratesâ€”around 3.5 percent or lowerâ€”according to the Mortgage Bankers
Association, there's been a lot of buzz about refinancing.
But how do you know if itâ€™s the right option for you? Before you take the leap, itâ€™s a good idea to weigh the pros and cons.
To get started, let's take a look at what refinancing is and why should you consider it.
According to the Federal Reserveâ€”the central bank of the United
States that raises and lowers short-term interest ratesâ€”refinancing
means paying off your existing mortgage and creating a new one. In the
process, you might change from an adjustable rate to a fixed interest
rate, consolidate first and second mortgages, or take advantage of a
lower interest rateâ€”all of which could help you save money.
In fact, "With the current international problems in Europe, China,
and those in our country, interest rates have fallen to levels not seen
since before I entered the industry in 1980," says Leonard Amescua,
senior loan officer at Mark 1 Mortgage in La Palma, Calif.
So if you're looking to refinance your mortgageâ€”or just trying to
figure out if refinancing makes sense for youâ€”read on to weigh more pros
Pro #1 - You Could Save Money
Saving money is a main reason for wanting to refinanceâ€”especially when there are record-low interest rates.
"In my marketplace where the average loan is in the $350K range,
lowering the interest rate from 5.25 percent to 3.625 percent for a
30-year loan will adjust the payment from $1,932.71 per month to
$1,596.18 on a new 30-year loan," says Amescua.
Looking at this example, you could save over $300 every month, which could add up over a 30-year term.
But keep in mind that factors like the size of your mortgage, your
current interest rate, and your new interest rate could affect the
amount of your savings.
Con #1 - You Have to Pay Refinancing Fees
If refinancing savings sound too good to be true, it's probably
because you're not considering the fees you'll have to pay to start the
"These fees can really add up," Amescua says. "Before you refinance,
you want to make sure that the savings will outweigh the fees."
But why are these fees so expensive?
"The true closing cost of the refinance includes an appraisal fee, an
underwriting fee, an escrow fee, title insurance, a recording fee, and a
notary fee. Taxes, insurance, and interest are separate from this
charge," adds Amescua.
Because you will be paying for several types of fees, make sure to
find out the full cost of refinancing before making a decision.
For example, if you're planning to move in two or three years, the
monthly savings from refinancing might not match the amount you paid in
refinancing fees. Therefore, it might make more sense to refinance if
you're planning to stay in your home longer than a few years.
Pro #2 - You Can Adjust the Length Of Your Mortgage
Believe it or not, if you pay a little bit more per month to change
from a 30-year loan to a 15-year loan, you could ultimately save a good
chunk of money on your mortgage.
For instance, if you took out a 30-year mortgage loan of $100,000 at 5
percent interest, your monthly payments would be $536.82, and you'd end
up paying $193,255.78 over the life of the loan. And the same loan
($100,000 at 5 percent) over 15 years would cost you $790.79 a month,
but it would end up costing you $142,342.85 over the life of the loan.
In case you don't have a calculator, that's a savings of $50,912.93.
Plus, you'd be free and clear of your mortgage 15 years faster.
On the other side of the spectrum, if you have a 15-year loan and can
no longer afford the monthly payments, you can refinance to a 30-year
loan. Yes, you may pay more in interest over the long run, but your
monthly bill will be lower, allowing you more money to spend on
necessities or to save for emergencies.
Con #2 - You Could Lose Money Due to Unexpected Events
What happens if you refinance and then end up having to move sooner
than expected? Whether it's due to a new job or a failed marriage, you
could lose a lot of money by moving out of your home soon after you've
Why? As mentioned in Con #1, the refinancing process includes fees
and closing costs, which means that you want to make sure that the money
you save overtime will be greater than the money you spend on the
For example, if you paid $2,400 in refinancing fees to lower your
monthly rate by $100, then had to sell your house in 18 months (at which
point you would have "saved" $1,800), the payoff balance and cost would
not cover the expense of the refinance. In fact, you'd be out $600 more
than if you hadn't refinanced at all.
However, with this same example, if you decide to refinance and stay in your house for 36 months, you could save $1,200.
The takeaway here: You might want to hold off on refinancing if your
job (or your marriage) seems shaky, or if there's a good chance you'll
get that out-of-state job you applied for.
Pro #3 - You Could Go from an Adjustable-Rate Mortgage (ARM) to a Fixed-Rate Mortgage
If you have an adjustable rate mortgage (a mortgage where the monthly
interest adjusts to reflect the current rate), you've probably
experienced a lower monthly mortgage payment over the last few years, as
interest rates have dropped.
So why would you want to refinance to a fixed rate mortgage?
According to Amescua, "the anticipation in the mortgage industry is that mortgage interest rates will eventually rise."
Of course, no one can say for certain if, when, or how much interest
rates will go up. But since we're looking at historically low rates
dipping into the 3 percent range right now, it's a safe bet that rates
will eventually increase again.
If that's the case, it makes sense to lock in your interest rate
nowâ€”while rates are lowâ€”rather than wait until rates go up again. Then
you might be stuck with a larger monthly payment for the foreseeable
Plus, a fixed rate could give you the peace of mind of knowing what
your mortgage will be month to month - or save you money from future
Con #3 - You May End Up Paying More if You Have Poor Credit
The unfortunate truth is, not everyone will qualify for the lowest
rates available. Why? Because bad credit, or a low Fair Isaac
Corporation (FICO) score, will lead to a higher mortgage interest rate,
meaning you'll pay more for your mortgage over the long term.
The term â€œFICO scoreâ€ refers to your credit score calculated with
software from the Fair Isaac Corporation. Basically, itâ€™s a number that
represents your creditworthinessâ€”and one that you should keep your eye
Why? Because according to Amescua, mortgage interest rates increase for every 20 point decrease in your FICO score.
To help monitor your credit score, you can check your credit report for free at AnnualCreditReport.com, the only authorized source by the Federal Trade Commission for free annual credit reports.
Unfortunately, when you want to see your FICO score, you'll need to
pay for the report. Look to the three credit bureausâ€”TransUnion,
Experian, and Equifaxâ€”to get access to that report.
A word of caution: avoid websites that offer free credit scores.
Often they will sign you up for automatic credit monitoring for a
monthly or yearly fee.