This article originally appeared on The Financially Independent Millennial and was republished with permission.
If you’re a new homeowner and not a finance professional, you may be new to refinancing a mortgage. In layman’s terms, refinancing is taking out a new mortgage to replace your old one.
You may not know that there’s actually no legal limit to how many times you’re allowed to refinance. But that doesn’t necessarily mean there’s no good or bad time to do so.
Here’s what to know about how often you can refinance your home mortgage.
Why Should You Refinance?
There are several reasons why you might refinance your home. Some are good reasons, and others, not so good (more on those later).
Refinancing can be a financially strategic move if you’re adequately poised to do so.
Get a Lower Interest Rate
Refinancing your home might get you a lower interest rate, which could mean less money you’ll have to repay in the long run. If you’re settling down in one spot for a while, this could be a great option, along with increasing your loan term.
If your credit score was lower when you purchased your home, or if interest rates were higher back then, it might serve you well to refinance now. Having a higher credit score now will set you up for landing a better deal on your home loan.
Reduce Your Monthly Payments
Let’s say you initially took out a 15-year mortgage on your house. Refinancing with a longer-term mortgage could drastically reduce your monthly payments.
Extending the length of your loan term will increase the overall amount of interest you’ll pay on the loan, but it will take a great deal of pressure off your monthly expenses.
A couple of other good reasons to refinance include:
Get Rid of Mortgage Insurance
If you purchased your home with less than stellar credit or made a deposit of less than 20% of your loan’s principal value, you were likely required to purchase private mortgage insurance (PMI).
PMI protects lenders in case you can’t make payments on your home loan. If your down payment is less than 20% of the home loan, you won’t take a financial architect to tell you that the lender owns more of your home. Indeed, the lender might have more to lose if your deal goes south.
If it’s been a while since you purchased your home, and you’re in a better place financially, refinancing your home will help you get rid of that PMI and save you even more on your monthly expenses.
Turn Your Home’s Equity into Cash
Though not always the wisest option, as it comes with some added expenses and reduces your home’s overall value, it could save you if you find yourself in a severe financial bind.
Some home loans require a “seasoning period” before you’re able to refinance, so if you recently bought your home, make sure it’s been long enough to refinance.
A seasoning period is when you purchase your home and when your lender says it’s okay to refinance. Your bank just wants you to build some equity first. But it’s crucial to note that this period can be as little as six months.
The Importance of Equity and Your Refinance
Equity is, according to Investopedia, “the difference between your home’s fair market value and the outstanding balance of all liens on the property.”
If this isn’t your first home mortgage refinance, you should consider how equity ties into the process. If you’re looking to cash out on your home’s equity, you should be aware that you can’t cash out on 100% of your equity at once.
Every time you cash out, you reduce the amount of equity you’re able to use for future refinances or home equity loans.
So, legally, there’s no limit to how many times you can refinance your home — as long as there’s equity to borrow against.
Downsides to Refinancing Multiple Times
All rules aside, there are some definite downsides to refinancing that you should consider before taking the plunge.
If you refinance, you’ll have to pay closing costs again, like:
- Fees attached to originating and processing the loan
- Insurance fees
- Escrow fees
- Appraisal fees
- Brokerage fees
There are some closing-cost-free mortgage refinancing options. However, these typically come with higher and variable interest rates, so tread lightly!
Another downside to refinancing is having to meet your lender’s standards again. This could be problematic if you’ve had a change in income since you originally purchased the home.
When you refinance, your lender might require you to pay a prepayment penalty fee for paying off your loan balance early (yeah, that doesn’t make sense, right?). This incentivizes borrowers to pay off the loan slowly, for its full term, instead of all at once.
Read more: How to Improve Your Credit Score
Alternatives to Refinancing Your Home
Contrary to what your lender may say, there are several alternatives to altogether refinancing your home.
Home Equity Loan
If you’re in dire need of cash flow, your home shouldn’t be the first thing you borrow against. But since it’s likely your most valuable asset, it will guarantee you the best possible loan options.
You can get a loan or line of credit with the equity in your home as collateral. This could be disastrous if you’re not careful, but worth it if you’re able to continue making interest payments.
Home equity loans are referred to as “secured loans” since the lender guarantees it with collateral (your home’s equity). Your next alternative to refinancing doesn’t require collateral, but they’re also more challenging to come by.
Unsecured Loan
Unsecured loans typically depend on your credit score. This may not get you as much cash as you need or a fair interest rate, but you won’t have to put your house up against it.
If you have excellent credit and don’t want to put your home up as collateral, we recommend taking an unsecured loan to get you out of a tight spot.
Aside from higher interest rates, some other potential downsides to unsecured loans might include:
- Early payoff penalties
- Hefty upfront fees for originating the loan
- Precomputed interest
Unsecured loans should be easy to understand. Someone lends you an amount of money, and you pay it back to them over with interest. If the loan is more complicated to understand than that, we recommend looking elsewhere!
Mortgage Recast
Your last alternative to refinancing your home is a home mortgage recast. If you’ve been making mortgage payments and have built equity into your home, you can always request a recast from your lender.
Not all lenders allow recasts, but many do. If you took out a government loan like a USDA or VA loan, for example, you are ineligible for a mortgage recast, and that’s due to how the government processes loans.
If you have a private loan, though, it’s likely that you can request a mortgage recast.
Most lenders require that you pay off a certain amount or percentage of your principal balance before you can request a recast.
This could give you a lower interest rate or lower monthly payment and solve your problems before you ever refinance.
Reasons Not to Refinance
We’ve gone through some good reasons to refinance, now here are some scenarios in which you probably shouldn’t.
Your Credit Score Increased
If your credit score recently increased, that doesn’t always mean that you’ll get a better deal on a new mortgage. If your credit score increases and you immediately refinance your home, you may lose those credit gains.
Applying for a new home loan (refinancing) allows creditors to take a closer look at your credit history. If you’ve only recently made some improvements, there’s no guarantee that you’ll get a better deal.
When you apply to refinance a loan, the hard inquiry on your credit report can cause a drop in your credit score. This is usually only a temporary drop, but it could affect your chances of landing a better deal.
So, it might be better to just stick with what you’ve got and continue improving your credit.
Cash Out for a Large Purchase
You probably shouldn’t cash out on your home equity to finance a vacation or buy yourself that fishing boat you always wanted.
A cash-out refinance might make sense to fund a well-thought-out small business investment, but frivolous purchases offering no return only help create bad habits.
Read more: The Basics of Investing In Real Estate – Updated In 2021
Interest Rates Slightly Dropped
If your market’s interest rates have dropped recently, that doesn’t mean you should go out and refinance your home mortgage for a better deal.
Unless the interest rates on your potential new mortgage are at least several percentage points lower, it won’t be worth it to pay closing costs again, especially not in the long run.
Conclusion
Refinancing your home might seem like a smart move if you’re in a tight spot.
It’s easy to see a quote for a lower monthly payment and consider jumping ship. But first, be aware of the potential downsides, and then calculate and recalculate to be sure you can make the new payments.
Remember: there’s no harm in seeking professional advice, either. Talk to a loan officer, a financial consultant, or your loan servicer before making any decisions.
