With mortgage rates hitting historic lows in recent years, refinancing has become a popular option for homeowners. The benefits of refinancing include lower monthly payments, locked-in low rates and extra cash available every month for purposes ranging from home repairs to paying down consumer debt.
The decision can be complicated for homeowners, so NerdWallet asked Forrest Baumhover — a financial advisor with Westchase Financial Planning in Tampa, Florida, and a member of NerdWallet’s Ask an Advisor network — about key factors homeowners should consider when deciding whether to refinance.
Besides lower monthly payments, what is another potential benefit of refinancing?
One advantage is potentially lowering your loan-to-equity ratio and not having to pay private mortgage insurance. If your down payment when you bought your home was less than 20% of the purchase price, chances are you had to buy PMI, the annual cost of which is generally 0.5% to 1% of the loan amount. For a $300,000 house, that could mean up to $3,000 per year.
After owning your home for a few years, building up equity and changing your loan-to-equity ratio, you may be able to refinance at a lower interest rate and without the PMI. Assuming a 1% PMI savings on a $300,000 home, you could apply that extra $250 per month to your mortgage payment and pay off your loan seven years early. If you took that same amount of money and invested it at 8% annually, you’d have more than $367,000 saved by the time you paid off your mortgage.
What are some tips for people planning to refinance?
Make sure you have a plan for the savings you’ll see every month. Whether it’s investing, paying down your mortgage or something else, make sure the savings doesn’t get wasted on “stuff.”
If you do refinance, the company usually grants a grace period before the new mortgage payments begin. This grace period can be a month or more, so take advantage of that month’s mortgage payment you don’t have to make. Some good options include paying down a credit card or making a needed home repair you’ve been putting off.
>> MORE: See today’s mortgage rates
What are the potential disadvantages of refinancing?
The thing to watch out for is excessive closing costs, which are a risk every time you look to refinance a mortgage. It’s important to know how long you plan to stay in the home — if you plan to move within two years, for example, the fees might not warrant the savings from PMI or from lower monthly payments. Make sure to do the math and calculate how many months of mortgage savings you’d need to make it worthwhile.