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Pros and Cons of Refinancing Your Home

Pros and Cons of Refinancing Your Home - TaxAct Blog

The decision to refinance your home can be a tough one. Not only can the process of refinancing seem like a lot of work, it’s often hard to know who to trust as some lender’s advertised offers sound too good to be true. But, when mortgage rates are near historic lows, refinancing your home may be one deal that’s too good to pass up.

Here’s a few things to consider when determining if refinancing is a smart move for you.

Pro #1: You may lower your current mortgage interest rate.

Typically, this is the main motivator behind refinancing. If you originally got your mortgage when interest rates were high, and you’ve never refinanced, you may be paying more than you need to. Taking the time to apply for a new loan at a lower rate could save you hundreds of dollars a month.

For example, if you have a $200,000 loan and are paying 7 percent interest on a 30-year fixed-rate mortgage, your total monthly interest and principal payments are probably about $1,331. If you refinanced at 3.8 percent, your monthly payment could be reduced to $932. That’s a monthly savings of $399!

Pro #2: You may be able to pay off other debts or get cash.

If your home is worth substantially more than the amount you owe, you may choose to take out a larger mortgage when you refinance. The cash you get back could be used to pay off car loans, credit cards or any other debt you may have. In some instances, this can be a good strategy if the debt you’re trying to pay off has high interest rates.

However, be careful not to overdo it or to habitually refinance your home every time the credit card balances get too high. It’s hard to pay off your house if you keep borrowing money from your equity.

Pro #3: Refinance an adjustable-rate mortgage to a fixed-rate loan.

An adjustable-rate mortgage (ARM) often comes with lower rates and payments in the first few years of the loan. But over the life of the loan, the interest rate – and your mortgage payment – can increase significantly.

When interest rates are low, refinancing your ARM for a fixed-rate mortgage may make sense – and it means your interest rates and payments are constant – even if interest rates skyrocket down the road. Knowing what your mortgage payment will be every month can help with budgeting and money management.

Con #1: Refinancing can be expensive.

Before you get started, make sure you know how much it will cost to refinance. Generally, refinancing costs between 3 and 6 percent of the loan’s principal. Therefore, it’s important not to be tempted to spend too much money refinancing if you know you won’t live in the home long enough to recoup the costs.

Ask yourself these questions before moving forward: how long do I plan to live in this house? How much money will I save by refinancing? The answers to these questions will help determine if refinancing is worth it.

Con #2: Refinancing isn’t always easy.

Many people find it very time-consuming to refinance. Expect to spend hours, or even days, gathering information and paperwork for your loan application.

Additionally, if something has changed in your financial life, such as your career or the amount of debt you carry, you may not be able to get a loan at the rate you expected.

Con #3: You may not be able to deduct your entire mortgage interest expense after refinancing.

If you refinance your home for the same amount you already owed on your mortgage, you can keep taking a mortgage interest deduction as always. The same applies if you take out a slightly larger loan to pay off some bills. As long as you itemize deductions on your tax return, you generally can deduct your total mortgage interest expense.

However, your deduction may be limited if you refinance and get a substantial amount of cash back. When you refinance, any money you receive in excess of your previous mortgage amount(s) is called home equity debt. You can only deduct your home equity debt interest on a balance of up to $100,000 ($50,000 if married filing separately).

What’s the highest home mortgage interest rate you have ever paid?

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About Sally Herigstad

Sally Herigstad is a certified public accountant and personal finance columnist and author of Help! I Can't Pay My Bills, Surviving a Financial Crisis (St. Martin's Griffin). She writes regularly at CreditCards.com, Bankrate.com, Interest.com, RedPlum, and MSN Money. She is an experienced speaker and a member of Toastmasters International. Follow Sally on Twitter.

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