Pros and Cons of Refinancing Your Mortgage

Refinancing your home can provide many financial benefits. It can lower your monthly mortgage payment, reduce the interest paid over the life of your loan, or allow you to access your home’s equity.

Unfortunately, refinancing comes with risk and may not always be your best option. Consider the benefits and costs before moving forward with a refinance.

Refinancing Pros

1. Lower Your Monthly Payment

One of the most common reasons people refinance their home is for an opportunity to lower their interest rate. If rates have dropped since you first took out your mortgage, there could be an opportunity to take advantage. Lower rates mean lower monthly payments, especially if you’re replacing your current mortgage with another 30-year loan.

You could also enjoy lower interest rates if you’ve improved your credit score. If your credit score was high enough to qualify for a mortgage but not excellent, you might not have received the best rates possible.

For example, let’s consider a borrower who took out a $300,000 30-year loan with an interest rate of 6.5%. Their monthly principal and interest payments would be $1,896. They refinance five years later, when their mortgage balance is around $280,000. If rates have decreased to 5.5% and they reset with another 30-year loan, their mortgage payment would drop to $1,594, a monthly decrease of over $300.

Related: How Much Do You Save With a 1% Lower Interest Rate?

2. Gain Equity and Pay Off Your Loan Quicker

Some people aren’t too concerned about reducing how much they pay each month. Instead, their goal is to eliminate their housing payment as quickly as possible, which can be done by refinancing into a shorter-term mortgage (15-year vs. 30-year). While this increases your monthly payment, you’ll build equity faster and repay your loan sooner.

3. Save On Lifetime Interest Costs

Lowering your interest rate and/or refinancing with a shorter-term loan can also reduce how much interest you pay over the life of your loan.

For example, let’s assume someone has a $300,000 30-year mortgage with an interest rate of 5.5%. Over the life of their loan, they would pay $313,212 in interest. Let’s assume that the person chooses to use a 15-year loan instead. While their monthly payment would rise, the total interest would be just $141,225.

4. Access Home Equity as Cash

Refinancing your mortgage isn’t always about lowering your monthly payment or reducing how much interest you’ll pay. Instead, it could be about accessing some of the equity you’ve built with a cash-out refinance. Maybe you need to pay off high-interest debt, or you want to complete a home renovation project.

One important thing to remember about a cash-out refinance is that, ideally, you want interest rates to be lower or near equal to your original mortgage. Otherwise, accessing your equity would cost a significant amount of money.

5. Change Your Loan Type

When you first took out your mortgage, your financial situation, goals, or market conditions might have pointed you toward a specific loan type—like an adjustable-rate mortgage (ARM) or an FHA loan. But as time goes on, that same loan might no longer serve your best interests.

For instance, ARMs typically offer a lower introductory interest rate for the first few years. That can be a smart move if you expect to move or refinance before the rate adjusts. But if you plan to stay in your home longer, refinancing into a fixed-rate mortgage can help you avoid payment spikes and lock in a predictable monthly payment for the life of the loan.

Likewise, FHA loans are known for their flexible credit and down payment requirements, which make them great for first-time buyers or those with less-than-perfect credit. But one of their downsides is mortgage insurance—especially since it doesn’t automatically drop off. If you've built at least 20% equity, refinancing to a conventional loan can eliminate mortgage insurance.

6. Add or Remove Borrowers

If you initially took out your mortgage with a spouse and you have since divorced or they have passed away, you might refinance to remove them from the mortgage. You could also refinance to add someone to the mortgage. If you got married and your spouse has a strong credit score, it might help you achieve a lower mortgage rate.

Related: How to Remove a Borrower from Your Mortgage

7. Fund a Renovation

A cash-out refinance isn’t the only way to fund a home renovation project. You could also refinance using an FHA 203(k) loan. This allows you to combine the cost of your current loan and any renovation costs you’ll have. When using an FHA 203(k) loan, you’ll need to qualify for an FHA loan and also meet the requirements for the 203(k) program.

Related: These 5 Renovation Refinance Programs Are Better Than a Cash-Out Refinance

Cons of Refinancing

1. Closing Costs

Refinancing your mortgage means paying closing costs, which can range from 2% to 5% of your loan amount. Closing costs include appraisal fees, origination fees, title insurance fees, and more.

The total cost depends on the lender, so it’s a good idea to compare these costs and interest rates simultaneously. Doing so allows you to find the best deal on your mortgage refinance.

Related: How Much Are Closing Costs for a Conventional Loan?

2. Potential for Increased Long-Term Costs

For many people, refinancing aims to lower their monthly payments, freeing up cash in their budgets. However, if this requires replacing their current mortgage with a new one or increasing the years on their loan, it will impact their overall cost.

Before refinancing, it’s important to consider whether the benefit of a lower monthly payment is worth paying more in interest over the life of the loan.

3. Potential for Higher Payments With a Shorter Term

Refinancing with a shorter-term loan can be a great way to repay your home sooner. However, doing so substantially increases your monthly mortgage payments. Before moving forward, ensure you understand the numbers and that the increased monthly payment makes sense for your budget.

4. Reduced Equity with a Cash-Out Refinance

If you complete a cash-out refinance, you’ll have the cash to use toward your financial goals. However, this reduces the equity you have in your home. Depending on current rates, this can lead to an increased mortgage payment and additional years before paying your mortgage in full.

5. Potential to Refinance Into a Higher Rate

If you’re planning to refinance and rates have risen since you first received your mortgage, you’ll most likely receive a higher interest rate, which could mean a higher monthly payment. Unfortunately, if your refinance is unavoidable, like when due to a divorce, you might not have any other choice.

If rates have increased, consider whether a refinance makes sense or if you’d be better off waiting a little longer.

6. Impact on Your Credit Score

When you apply for a loan, lenders complete a hard inquiry on your credit report to understand your financial situation and assess your ability to repay your loan. Hard inquiries remain on your credit report for up to two years and can cause a slight drop in your credit score. However, this decline usually only lasts a few months.

When you refinance your mortgage, you may also experience a slight decrease in your credit score because you're closing your old mortgage. This happens because the average age of your credit accounts determines part of your credit score. By replacing an older loan with a new one, the average age decreases. Although these declines in your credit score are common, most people recover quickly.

Alternatives to Refinancing

Refinancing has a lot of advantages. However, several disadvantages of refinancing a home loan also exist. Before starting, make sure you also consider some available alternatives.

Home Equity Line of Credit (HELOC)

If you’re considering refinancing to access some of your home's equity, you could consider a home equity line of credit (HELOC) instead. HELOCs are secured by your home and give you a revolving line of credit, providing the flexibility to use your equity when needed.

While most HELOCs have slightly higher interest rates than a traditional mortgage, many allow you to avoid closing costs. However, your monthly payments can fluctuate because most HELOCs have variable interest rates.

Keep in mind that HELOCs are considered second mortgages, meaning you’ll have a monthly payment on top of your regular mortgage payment. Failure to make payments on your HELOC could result in foreclosure.

Home Equity Loans

Home equity loans are similar to HELOCs except that you receive a lump sum of cash instead of having access to a revolving line of credit. This is ideal for a one-time need like debt consolidation or a major home improvement project. Additionally, home equity loans typically come with fixed interest rates instead of a variable interest rate, making your monthly payments more predictable.

Recast

If you want to reduce your monthly payments, a mortgage recast could help you accomplish your goal without refinancing. With a recast, you use a lump sum of cash to lower your principal balance. Your lender then reamortizes your loan, helping to reduce your monthly payments. Your loan's interest rate and the number of years left remain unchanged.

Loan Modification

If you’re struggling to make your monthly mortgage payments, you might consider refinancing to help lower your monthly payment. However, if you’ve missed payments, refinancing could be difficult. Instead, calling your lender and discussing loan modification options might make sense.

To be considered for loan modification, most lenders require submitting proof of hardship, such as a job loss, illness, or divorce. Lenders could choose to lower your interest rate or increase the years on your loan. If you prove you can make the new monthly payments, the loan modification terms will stay in effect.

Run the Numbers and Talk to a Professional

Before moving forward, weigh the pros and cons of refinancing your home. Every person's situation is different, so while refinancing might make sense for some, it might not make sense for everyone. Don't hesitate to speak with a professional to discuss your options. They can help you ensure that you can accomplish your goals.