Refinancing your Home

Financial Considerations in Refinancing your House: Pros and Cons

If you’ve owned your home for a couple of years, you might have started thinking about refinancing. Maybe interest rates have dropped, and you want to save money, or you want to tap into your home’s equity to remodel your kitchen.

Learn about the pros and cons of refinancing your house and how it could impact your financial situation so you can make the best decision for your family.

Pros of Refinancing your House

Here are some of the reasons why you might consider refinancing.

• Lock in a lower interest rate and lower monthly payment
• Refinance into a better loan product
• Free up equity for a remodel or other purposes

Interest rates fluctuate over time. If rates have dropped significantly since you first bought your home, it could be worthwhile to refinance. Since you’ll pay fees to refinance, most financial advisors recommend that you plan on staying in your home for at least five years after the refinance.

Another reason to refinance is to get into a better loan product. An Adjustable Rate Mortgage, or ARM, enables homeowners who expect their income to grow in the future to get into a home now. But after a set time period, typically five years, the interest rate resets. To avoid a rate hike, you might think about refinancing.

While home appreciation isn’t guaranteed, in most cases, your home’s value will grow over time. A cash-out refinance allows you to tap into your increased equity. You could use it to remodel your kitchen, pay for a child’s college education, or consolidate and pay off higher-interest debt.

Whatever your reasons for thinking about refinancing, weigh them against the downsides of the process.

Downsides to Refinancing your House

There are costs involved in a refinance which you should consider before filling out the online application. Banks charge fees which could become substantial. Evaluate those fees against the cost savings of a lower mortgage payment, and take into account how long you plan on staying in your residence, before going through with a refinance.

Common fees you might have to pay include;

• Application fees
• Processing fees
• Underwriting fees
• Appraisal fees
• Inspection fees
• Title fees
• Attorney fees
• Recording fees

On average, fees could be between 2-4% of the amount you’re refinancing. That percent doesn’t include any mortgage interest, or points, that the lender could ask you to pay at closing. If you don’t have this money available, or if spending it would negatively impact your finances, a refinance isn’t a good idea.

In addition to the expense of refinancing, there’s your time. Applying to refinance a home takes just as much time as applying for a mortgage. The underwriters will request the same amount of information, from paystubs to tax returns, and you’ll be busy pulling together documentation and answering questions.  

Another downside to a refinance is that it could reset the clock, so to speak, on paying off your home. If you’re in the 15th year of homeownership on a 30-year loan and you refinance for another 30-year loan, you’ve extended your repayment term. If your goal was to pay off your home sooner, this could be disheartening.

Tax Implications of Refinancing a House – Points Paid

Refinancing your house can help reduce your tax burden in April. If you itemize your deductions, you can deduct mortgage interest.

Most lenders require that you pay points up front in a refinance. This protects their profit on the loan. Points are tax-deductible, either over time or during the year you refinanced your house. To deduct the full amount in the same year, you must meet the following requirements;

• You refinanced your principal residence.
• Paying points is customary where you live.
• The points you paid weren’t excessively high.
• Points didn’t cover other fees, such as appraisal and inspection fees.
• Can’t have borrowed from your lender or mortgage broker to pay the points.
• Points were computed as a percentage of your mortgage’s principal.
• They’re shown as points on your settlement statement.

If the points you paid don’t meet these requirements, you can deduct them over the life of the loan. If you sell the house before you’ve fully deducted the points you paid, you can take the remainder of the points paid as a lump sum in that year. If you have any questions about their deductibility, hire a professional to prepare your taxes.

Tax Implications of Refinancing a House – Interest Paid

Another way that a refinance could impact your taxes would be if the amount you pay in mortgage interest goes up across the board. Some homeowners refinance to get out of an ARM that will be resetting soon and to lock in a fixed payment, not necessarily to get a lower interest rate.

If you’re now paying more interest in your monthly payments, you’ll see a bigger deduction at year-end.

Refinancing your home could be an excellent way to improve monthly cash flow or realize your dreams. Just make sure you have the time available and that a refinance will lead to a net benefit for your financial situation in the long run.