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The pros and cons of refinancing your home

If you're thinking of refinancing your home, here's what to consider, according to a community loan officer.

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Editor's Note: APYs listed in this article are up-to-date as of the time of publication. They may fluctuate (up or down) as the Fed rate changes. CNBC will update as changes are made public.

Refinancing your mortgage may be able to give you some breathing room by lowering your monthly payments and/or saving you money over time. At the same time, refinancing can be a little complicated, especially if your credit score is less than ideal or you're not completely sure what to expect. 

When you refinance, it means you're essentially taking out a brand new loan on your property, often for the remainder that you owe (but not always). Ideally, this new loan comes with better terms than your old one. This depends on a number of factors, including current mortgage rates, how much equity you have in the house (i.e. how much of the loan you've already paid off) and what your credit score is when applying.

While refinancing sounds great on paper, it may not always put you in a better position. It's best to weigh the pros and cons, taking your personal situation into account.

CNBC Select spoke with Darrin Q. English, a senior community development loan officer at Quontic Bank, about the pros and cons of refinancing your home. Here's what to keep in mind.

The benefits of refinancing your mortgage

Depending on what kind of loan you are eligible for, refinancing might offer you one or more benefits, including:

  • a lower interest rate (APR)
  • a lower monthly payment
  • a shorter payoff term
  • eliminate private mortgage insurance (PMI)
  • the ability to cash out your equity for other uses

One of the best mortgage lenders for refinancing is Rocket Mortgage due to its flexible loan repayment terms, fast approval process and lower credit score requirements.

Rocket Mortgage

  • Annual Percentage Rate (APR)

    Apply online for personalized rates

  • Types of loans

    Conventional loans, FHA loans, VA loans and Jumbo loans

  • Terms

    8 – 29 years, including 15-year and 30-year terms

  • Credit needed

    Typically requires a 620 credit score but will consider applicants with a 580 credit score as long as other eligibility criteria are met

  • Minimum down payment

    3.5% if moving forward with an FHA loan

Terms apply.

Plus, the refinancing process can be relatively easy with lenders who offer a virtual experience. In addition to Rocket Mortgage, Better.com Mortgage and SoFi provide an entirely digital application process and allow you to get rates in a matter of minutes.

Better.com Mortgage

  • Annual Percentage Rate (APR)

    Apply online for personalized rates; fixed-rate and adjustable-rate mortgages included

  • Types of loans

    Conventional loan, FHA loan, Jumbo loan and adjustable-rate mortgage (ARM)

  • Terms

    10–30 years

  • Credit needed

    620

  • Minimum down payment

    3.5% if moving forward with an FHA loan

Terms apply.

SoFi

  • Annual Percentage Rate (APR)

    Apply online for personalized rates; fixed-rate and adjustable-rate mortgages included

  • Types of loans

    Conventional loans, jumbo loans, HELOCs

  • Terms

    10 – 30 years

  • Credit needed

    620

  • Minimum down payment

    3%

Terms apply.

The most immediate benefit of refinancing is that it helps cash-strapped borrowers find space within their monthly budget. This could be advantageous if you expect your cost of living to increase (maybe you're having a baby) or if your income has decreased (from job loss or decreased hours).

But when you refinance, you can also use it as an opportunity to use some of the cash from your home's value toward other costs: "Essentially 50% of the folks are pulling cash out, and they are looking at either reinvesting that money in other properties or sending their children to college or something like that," English explains.

Other times, homeowners want to refinance in order to change the term of their current mortgage from a 30-year term to 15 years. Depending on the interest rate you qualify for, this could change your monthly budget only slightly while helping you pay off your loan faster.

When you refinance, you might also get to skip a mortgage payment while the new loan is originated and the paperwork is being processed.

"You have 30 days before the actual amortization begins. So there are times where you can have as many as 60 days before the payment is due," says English. While this is not a reason to refinance, it's a nice perk and can be a good opportunity to build up an emergency fund if you don't already have one in place, using the money that would usually go toward your mortgage payment to fund the account.

The pitfalls of refinancing your mortgage

While refinancing has many positive benefits, it could come with pitfalls if you're not prepared.

Closing costs

To begin with, refinancing loans have closing costs just like a regular mortgage. The mortgage lender Freddie Mac suggests budgeting about $5,000 for closing costs, which include appraisal fees, credit report fees, title services, lender origination/administration fees, survey fees, underwriting fees and attorney costs. It all depends on where you live, the value of your house and the size of the loan you're taking out.

Some lenders might offer a no-cost refinance, but that usually just means the closing fees are being wrapped up into the amount of your loan. If you refinance with your existing lender, you may get a break on mortgage taxes, depending on your state's laws.

"That's a carrot that they dangle," says English. However, you should always compare rates, terms and programs.

Once you calculate your closing costs, do some quick math to make sure that you'll make that money back by saving on your new monthly payment. If your closing costs are $5,000 and you save $500 per month on your new mortgage, it would take 10 months to break even. However, if you only saved $200 per month, your "break-even point" would be 25 months (just over two years). Stay in the home for less time than that, and you won't truly be saving money long-term.

You may end up in more debt

You also need to have a clear idea of how you'll use the money you free up when you refinance. This is particularly true if you plan on cashing out your equity. If you plan to reinvest your equity in another property, education or another purpose, be sure to weigh the costs versus the rewards. 

And if you plan on refinancing so you can pay off high-interest debt, have a clear plan to avoid overspending in the future: "One of the downfalls that I've seen is that folks will have all of this new disposable income, from a lower rate and/or longer terms," says English. "And now they might be saving anywhere from $500 to $1,000 a month on the mortgage. They pay off their debt, but they have the ability to charge those cards again and they fall right back into the trap."

If you spend the equity you've earned on debt payoff, you'll have to wait until your home value increases and you've put more years of payments toward the mortgage before you're able to tap into that source of cash again.

It's also worth remembering that banks have limits on how much equity you can pull out from your home. Most banks won't let you cash out more than 70% of the home's current market value, says English. You shouldn't think of your home as a source of quick cash.

A slight dip in your credit score

Finally, although only temporary, refinancing your mortgage could have a negative impact on your credit score as the lender will perform a hard inquiry to evaluate your creditworthiness.

A better option for quick cash access

A better option to make sure you have access to cash is to build up an emergency savings fund, says English. "It's important that we all have reserves and something to fall back on. That is the safest way to prepare for the future."

Don't put off saving just because you think you can't afford it. You can save $1,000 in a year by setting up a weekly $20 direct deposit from your checking account into a high-yield savings account. Over time, you can increase the amount you save, especially if your mortgage payments drop because you refinance.

Look for a high-yield savings account that has no monthly fees, no minimum deposits and no balance requirements. CNBC Select's top pick is LendingClub High-Yield Savings due to its strong APY and free ATM card. It is an easy-to-use, straightforward savings account for when you're just getting started.

LendingClub High-Yield Savings

LendingClub Bank, N.A., Member FDIC
  • Annual Percentage Yield (APY)

    5.00%

  • Minimum balance

    No minimum balance requirement after $100.00 to open the account

  • Monthly fee

    None

  • Maximum transactions

    None

  • Excessive transactions fee

    None

  • Overdraft fees

    N/A

  • Offer checking account?

    Yes

  • Offer ATM card?

    Yes

Terms apply.

For an even higher APY, the UFB Secure Savings is a good option.

UFB offers one of the highest interest rates on the market and charges no monthly fees, allows unlimited transfers and has no minimum deposits. Customers also get a free ATM card for easy access to their cash.

UFB Secure Savings

UFB Secure Savings is offered by Axos Bank, a Member FDIC.
  • Annual Percentage Yield (APY)

    Earn up to 5.25% APY

  • Minimum balance

    None

  • Monthly fee

    None

  • Maximum transactions

    No max number of transactions; max transfer amounts may apply

  • Excessive transactions fee

    None

  • Overdraft fee

    Overdraft fees may be charged, according to the terms, but a specific amount is not specified; overdraft protection service available

  • Offer checking account?

    Yes

  • Offer ATM card?

    Yes

  • Terms apply.

Bottom line

Refinancing your mortgage can allow you to change the term of your current mortgage to pay it off faster or lower your monthly payment. It can also be a way to access cash if you're cashing out your equity. However, it's not wise to think of your home as a source of quick money, especially if you're planning to use it to pay off debt. To avoid tapping into your home equity in tough financial circumstances, work on adding to your savings and building up your emergency fund.

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Editorial Note: Opinions, analyses, reviews or recommendations expressed in this article are those of the Select editorial staff’s alone, and have not been reviewed, approved or otherwise endorsed by any third party.
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