People come to the topic of refinancing their home mortgage for a number of reasons, chiefly to take advantage of lower interest rates. When rates drop substantially from what you're currently paying, not only are lower payments a possibility but so is owning your home faster. A refinance is also the chance to switch mortgage companies if that's what you desire.
Since rates are lower now than they have ever been in history, curiosity about refinancing has soared. How high is the demand? According to the Mortgage Bankers Association last month, refinance activity increased 89% in December 2020 compared to the same week a year before.
Getting an interest rate 1% or 2% lower than your current rate can lower your monthly payment a lot. Even better, it means more of your money actually goes toward the house, building equity, and not into the bank's pocket as interest.
The appeal of a refi is plain to see. Everywhere you look, folks are jumping in the refi pool. You may be at the point of dipping your big toe in the water. As you ponder a mortgage refinance, what can you learn from those who jumped in before you?
"Our Loan Amount Actually Went Up."
You go into a mortgage refinance with your eye on a lower monthly payment, so what's the deal when your loan balance goes up? Even if you didn't do a cash-out refinance, when all the paperwork is over, you could be looking at a higher loan amount than before.
Every homeowner's situation will vary, but the general reason your loan balance could increase is because of closing costs. Banks need to get their cut, after all. It costs money to save money. When you replace an old home loan with a refinance of the same amount, but roll the closing costs into the new loan, your balance bumps up. You could pay the closing costs up front instead, a money-saving step over the long term, which we have written about before.
Offsetting the slight increase in the loan balance is, of course, your lower monthly payment. Plus, you might be paying less for private mortgage insurance now.
Some homeowners go into a refinance with an eye on shortening their term, not necessarily lowering their payment.
Even better, if your loan amount goes up, in part, because you whittled a year or more off the loan term during the refinance, you come out ahead. Let's say your previous loan balance was $225,000. A refinance lowered your payment $200, which you're happy about. Rolling the closing costs into the refinance raised the loan amount to $233,000. But your old mortgage had 22 years left, and your new one is 20 years. You just saved two years' worth of interest, and you're two years closer to total home ownership.
Some homeowners go into a refinance with an eye on getting a shorter loan term, not necessarily lowering their payment. For them, they can comfortably make their current payment but want to refinance at today's rock-bottom rates so that their payments go more toward the home than the bank. Their payments get them closer than before to the glorious day when they have paid the mortgage off.
"We Didn't Expect Our PMI to Drop So Much."
Homeowners are required to pay private mortgage insurance (PMI) when they put less than 20% down on a home. Since the average down payment for a newly built home was 6% in 2019, according to Forbes, a lot of folks pay PMI. People come to think of it as simply another "cost of doing business," like their homeowners insurance and utility bills.
But PMI can significantly decrease when you refinance. "I thought we'd pay that $165 every month until we paid 20% of our loan off, but when we refinanced, that amount decreased significantly—our new PMI payment will be $39 per month," a homeowner told Business Insider.
In the wake of a refi, more of each monthly payment is going toward equity. This tweaks the equation that was used to establish your original PMI payment. The more equity you have in a home, the lower your PMI. Also, the refi probably improved your debt-to-income ratio over what it was when you originally bought the house. And your credit score could be better as well. These are all reasons you might be pleasantly surprised by a lower PMI payment after a refi.
"We Wish We Hadn't Rolled Our Other Debt Into the Refinanced Mortgage."
With mortgage interest rates so low, many homeowners are tempted to lump their other debt into a refinanced mortgage. Every month they might stare down a few hefty credit card bills and one or more student loan payments. They wonder if rolling these debts into a refi makes sense.
"Nope. Just don't," writes personal finance guru Dave Ramsey. "You want to pay off your smaller debts first (and get energized from those wins). Lumping your student loan debt into your mortgage means it’s going to take a lot more time to pay off those loans and your mortgage too. It puts you even further away from completing either of those goals. No thanks."
You shouldn't lump other debt into a refinanced mortgage for these four reasons.
- The biggest reason you shouldn't convert credit card debt to mortgage is that unsecured debt would become secured debt. If you miss a few credit card payments they don't come to your house and take the things you bought with the card. If you lapse on a student loan your college degree is not in peril. But if you miss enough mortgage payments they could take your home.
- It will probably take you much longer to pay off your mortgage if you lump credit card debt into it.
- It damages your credit score because you've shortened the average age of your accounts.
- It makes your home harder to sell because you'll want to hold out for an offer equal or greater than your current mortgage balance. Buyers will offer what they think the house is worth, not what it's worth plus your old student loans and credit cards.
A winning strategy.
You can still channel the financial win of a mortgage refinance into ridding yourself of credit card debt or a student loan without converting unsecured debt to secured or unduly enlarging your mortgage balance. Just handle it with your budget: Put all the money you save on lower house payments toward paying off other debt. Make dispatching other debt a priority over new cars, new electronics, and so on, and use what you save from the refinance each month to reach that goal.