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Refinancing Revisited: Weighing the Pros and Cons

The low mortgage rate environment led to a refinancing boom in 2020, and the trend is likely to continue with rates holding steady at all-time lows. While a “refi” may seem like a no-brainer for many homeowners, it can be confusing to weigh immediate savings vs. long-term implications. Here are four ways to demystify the process.

Understanding refinancing at the consumer level:

What is “refinancing” anyway?

In general terms, a refinance occurs when a debtor chooses to revise the interest rate, payment schedule and terms of an existing credit agreement. While there may be other reasons to refinance - a change in salary or other personal financial circumstances - a substantial change in the interest rate environment is the typical reason.

How does it impact monthly mortgage payments?

The primary reason for a refinance is to lower monthly payments. A drop in interest rate from just 4.5% to 3.5% could lower monthly payments by several hundred dollars a month. But the shorter-term benefits of refinancing can also lengthen the life of the loan, which means paying more interest in the long run. A younger or middle-aged homeowner could save a significant amount of money over time by refinancing. On the other hand, a person closer to retirement may want to consider the implications more carefully.

What kind of fees are involved?

The other element to weigh is the upfront fees involved in a refinance, which can be up to 1.5% of the overall amount owed. There are also loan application, home appraisal, origination/underwriting and credit report fees. Banks and credit unions may offer more favorable terms - such as “absorbing” the fees into the overall mortgage.

The Bottom Line

The rush to refinance that occurred in the first half of 2020 can lead homeowners to feel what the millennial generation refers to as FOMO or “fear of missing out.” But fear is not the best motivator. While a refi is a great decision for many homeowners, it’s always wise to be aware of the larger implications. Rather than looking at a mortgage as an isolated financial obligation, the full financial picture unique to each person should be part of the evaluation process. A tailored cost-benefit analysis should factor in immediate savings vs. long-term implications and - perhaps most importantly - individual financial circumstances outside of the mortgage.

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