Owning a home can help you build long-term wealth and positively impact you and your family’s financial future. And when done correctly, refinancing can help you reap more benefits and get even more value out of homeownership.
But just like purchasing a home, refinancing a home comes with certain risks or cons that you should be aware of.
- What are the potential risks or downsides to refinancing that I should be aware of?
- What does “net tangible” benefit mean when it comes to refinancing a mortgage?
- What are some of the benefits that homeowners can get out of refinancing?
What does “net tangible benefit” mean when refinancing a mortgage?
Mortgage advisors have an ethical responsibility to look out for the “net tangible benefit” of their borrowers.
In other words, if a mortgage advisor is going to help you refinance your home, they are expected to only do so if it makes sound financial sense for you. Meaning that all the benefits you get from refinancing should outweigh any of the risks or costs involved.
That’s your right as a borrower, to work with a mortgage advisor who’s looking out for the net tangible benefit you get from refinancing.
And yes in many cases, homeowners get a lot of benefits from refinancing (especially if you’re working with a great mortgage advisor who really has your best interests at heart).
However, there is the unfortunate possibility in which a not-so-great lender might push a homeowner into refinancing when it doesn’t really make sense for them.
That’s a worst case scenario situation. Regardless, as a homeowner, you deserve to be informed about that possibility.
Why do homeowners choose to refinance? What are some of the potential benefits to refinancing?
After buying your home, circumstances may change.
The market can change, your life circumstances or finances can change. Therefore, it might make sense for you to change your mortgage along with that, so you can get more benefits out of homeownership.
Benefits to refinancing include (but are not limited to):
- Getting a lower interest rate, which can save you significantly over the life of your loan
- Tapping into your home’s equity (either to pay off high-interest debts, to invest in assets that will help you grow your wealth over the long term, or for various other reasons)
- Eliminating mortgage insurance fees to save money
- Lengthening the term of your loan to lower your monthly payments
- Shortening the term of your loan to reach full ownership sooner
- Converting an adjustable rate mortgage into a fixed rate mortgage
What are some of the potential downsides to refinancing?
First off, you still have to qualify for a refinance similar to how you had to qualify for your mortgage.
This means sending over documents, going through the approval process, and having your credit pulled again. If your credit has dropped a lot since you first bought your home, this might make it difficult to get approved.
(Side note: You may be able to opt for a “streamlined” refinance. This “streamlined” option has a faster approval process and doesn’t require you to provide as many documents.)
In addition to your credit, your lender will also look at your Loan-To-Value ratio or your LTV. Your LTV is an indicator of how much equity you’ve built in your home. The more equity you’ve built, the lower your LTV.
The higher your LTV, the more difficult it might be to refinance. Typically, homeowners won’t qualify for a refinance if their LTV is 80% or higher.
Another factor to consider before refinancing is closing costs.
In order to refinance your mortgage, you’ll have to pay closing costs for things like taxes and lending fees. Depending on your state and other factors, these closing costs may range from 2% to 5% of the loan amount.
The third risk or con to keep in mind is resetting your amortization schedule. Let’s break down what that means:
Let’s say you bought a home 3 years ago and got a 30 year mortgage. But you decide to refinance and you go with that 30 year loan term again.
This could potentially reset your amortization schedule, meaning you’re starting that 30 years over again. It might set you back so it takes longer for you to pay off your mortgage and fully own your home.
Also, it’s possible that even if you get a lower interest rate, if you extend to a longer loan term, then you might actually end up paying MORE in interest over time.
Another risk to refinancing is that your monthly payment could increase. This typically happens if you go from a longer loan term to a shorter loan term.
In this case, it’ll take less time for you to fully pay off your loan, but you’ll have to pay a higher amount each month to get to that point.
The next con to keep in mind is that you could reduce the equity you have in your home.
If you do a cash-out refinance and tap into your home equity, you’re taking some of that equity out to pay for something else, whatever it may be, whether it’s debt consolidation, home renovation, other investments, or whatever you decide to do with that money.
Taking that cash out will reduce the equity you have in your home.
And that’s not necessarily a bad thing, especially if you have an honest conversation and really ask yourself, Is this worth it?
Does it make sense for me to take this cash out of my equity to pay for something else that is truly going to benefit me?
Am I investing this cash into something that’s going to help me build wealth? Or, Am I investing this into something that’s going to help me improve the quality of my life?
That might be a conversation you have with a financial advisor to determine what you should spend that money on. The potential risk here is if someone uses their home equity for an impulsive purchase that doesn’t benefit them in a way that they’d hoped for.
Risks Of Refinancing: The Takeaway
There are several benefits you can get from refinancing your home. As circumstances change, it may make sense to change your mortgage along with that, helping you to get even more value out of homeownership.
When it comes to getting a great deal on your home refinance, you and your mortgage advisor have to really weigh the pros and cons here.
It’s all about taking the short term AND the long term impacts into account and asking yourself, What’s the net benefit here?
That’s your decision to make, and a great mortgage advisor is going to take the time to give you ALL the information you need, so you can make the best decision for you and your financial future.