Deciding whether to refinance your mortgage or vehicle at a lower rate isn’t always easy. While there are coms clear benefits, you’ll also face a few drawbacks. In some cases, those negatives aren’t immediately noticeable if you don’t do your research first. However, you may feel that the positives outweigh them. If you’re thinking about refinancing at lower rates, here are the pros and cons you need to consider.
Pro: You Might Save Money
One of the biggest benefits of securing a lower rate on your mortgage or auto loan is the potential savings. First, you usually end up with a smaller payment, and that can be a boon for your monthly budget.
Second, you could pay less in interest, leading to a long-term savings, too. However, this isn’t technically guaranteed. Your interest rate is only one factor in this equation; the other big one is the length of your new loan.
If your existing mortgage only had, for example, 15 years left, and you refinance into a 30-year loan, you could actually end up paying more in interest over the life of the loan, even with the lower rate. However, if you had 27 years left on your initial loan and refinance it with a lower rate 30-year mortgage, you may not spend more in interest, depending on the exact terms.
Con: You Might Reset the Clock
When you refinance your loan, you generally select from a few term lengths. For mortgages, 15, 20, and 30 years are most common. For vehicles, 36, 48, and 60 months are the norm. That means there may not be an exact match to the number of months or years you have left on your existing loan.
While this isn’t always a problem, if you only plan on making minimum payments, you could be defaulting to a longer term than your existing loan has left. As a result, you’ll have to deal with the monthly payment longer, and that does impact your budget and, potentially, other aspects of your finances, like savings goals.
Pro: Pay Your Debt Off in Less Time
As mentioned above, when you refinance, you typically have to choose from a handful of set term lengths. However, there is no rule that says you have to choose a longer one than what’s left on your current loan.
With a lower rate, you may be able to select a shorter term and keep your monthly payments affordable. For example, if you have 20 years left on your 30-year mortgage but choose to refinance with a lower rate 15-year loan, you could come out ahead financially in the long-run. Not only will you be able to tackle the debt faster, but you’ll also pay less in interest.
Con: Refinancing Fees and Expenses
When you refinance a loan, particularly a mortgage, you’ll have to contend with some fees. For example, you may need to pay mortgage refinance closing costs, origination or underwriting fees, escrow fees, appraisal fees, or similar costs associated with securing the mortgage.
Exactly what you owe will depend on the lender you refinance with, as each lender has their own fee structures. Some lenders do offer no-closing-cost refinance options, for example. Or, if you aren’t doing a cash-out refinance, you may not need an appraisal.
However, if you do have to contend with fees, they could offset any savings you receive from securing the lower rate. It’s critical to do the math to estimate their impact. That way, you can figure out if refinancing at lower rates is actually a smart financial move.
Pro: You Might Reduce Your Debt-to-Income Ratio
Your debt-to-income ratio is a comparison between your monthly debt obligations and your monthly income. Usually, lenders use it to determine your ability to repay a loan, credit card, or another form of debt.
When your debt-to-income ratio is lower, you may be viewed as a safer risk. If your debt-to-income ratio is too high, a lender may not view you as a good bet, causing them to deny you financing.
If you refinance your mortgage with a lower rate, you may be able to shrink your debt-to-income ratio. This could make it easier for you to secure credit while you are still paying down your mortgage, should the need arise.
Con: You’ll Impact Your Credit Score
When you refinance your loan, you’re going to end up with a hard pull on your credit score. Additionally, if you move forward with the refinance, the new loan will reduce the average age of your accounts.
While these aren’t universally guaranteed to hurt your credit score, they certainly can. The impact will depend on the number of credit inquiries you have listed on your report within the past two to three years, as well as the age of your other credit accounts and other factors.
However, it’s almost guaranteed to make some kind of impact, and it’s critical to keep that in mind. This is especially true if you may need a different type of financing in the near future, as a decline in your credit score, if one happens, could make that harder to obtain.
Pro: You May be Able to Tap Your Equity
If you are refinancing a mortgage and have some equity, you might be able to access it when you refinance. Cash-out refinancing allows you to access some of your home’s value, giving you money you can use for any purpose. For example, you might take the cash and fund some home improvements or use it to pay off high-interest debt.
Generally, the interest rates on mortgages are lower than most other forms of consumer debt, particularly unsecured personal loans and credit cards. That can make a cash-out refinance an attractive option for handling expensive home repairs or getting out from under credit card debt.
Now, this isn’t a risk-free move. Your home secures the mortgage and, if you take out enough money to put a strain on your budget, you could lose your house if you can’t make the payments. However, that doesn’t mean cashing out can’t be beneficial. It will all depend on what you intend to do with the money and the current state of your finances.
Cons: Refinancing At Lower Rates Isn’t Fast
If you’re in financial trouble right now, refinancing may not solve your immediate woes. Whether you’re looking at refinancing your mortgage or vehicle, the process can take a little bit of time, especially with the former.
When you refinance a mortgage, you’re essentially going through the same process you did when you first financed a house. It can take weeks or months to finish, depending on the lender, the refinance type you choose, and your financial situation. Plus, you have to keep paying on your current mortgage (and other bills) until the process is complete, as a missed payment while the refinance is in-process could bring the whole thing to a halt.
Even vehicle refinancing isn’t always immediate. While it can certainly be quicker than refinancing a mortgage, there’s no guarantee it’ll be done in just a day or two. This is especially true when it comes to closing out the old loan.
Regardless of whether you successfully complete the refinance process and are formally approved, if you have a payment due on your existing loan within a few days, the pay-off through your new lender might not process before that due date arrives. If that’s the case, you’ll have to make the payment or take a hit on your credit.
Ultimately, refinancing at lower rates can be beneficial, but it isn’t a risk-free proposition. Make sure you understand the risks and drawbacks before you begin. Also, do the math to make sure that the lower rate genuinely results in a meaningful savings. That way, you can make the financial move that’s right for you.
Can you think of any other refinancing at lower rates pros and cons? Share your thoughts in the comments below.
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Tamila McDonald has worked as a Financial Advisor for the military for past 13 years. She has taught Personal Financial classes on every subject from credit, to life insurance, as well as all other aspects of financial management. Mrs. McDonald is an AFCPE Accredited Financial Counselor and has helped her clients to meet their short-term and long-term financial goals.