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Advice

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.

During this era of economic uncertainty, refinancing your mortgage can give you some breathing room by lowering your monthly payments and/or saving you money over time. Americans are applying for refinancing loans at a 38% higher rate compared to last year, in part because the Fed slashed interest rates when the coronavirus pandemic hit and borrowing is now more affordable.

But 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 factors, including 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
  • the ability to cash out your equity for other uses

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.

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 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 rewards. 

And if you plan on refinancing so you can pay off high-interest debt, have a clear plan 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 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. 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 Marcus by Goldman Sachs High Yield Online Savings, with no fees whatsoever and easy mobile access. It is an easy-to-use, straightforward savings account for when you're just getting started.

Marcus by Goldman Sachs High Yield Online Savings

Marcus by Goldman Sachs High Yield Online Savings
Information about the Marcus by Goldman Sachs High Yield Online Savings has been collected independently by CNBC and has not been reviewed or provided by the bank prior to publication. Goldman Sachs Bank USA is a Member FDIC.
  • Annual Percentage Yield (APY)

    0.60%

  • Minimum balance

    None to open; $1 to earn interest

  • Monthly fee

    None

  • Maximum transactions

    Up to 6 free withdrawals or transfers per statement cycle *The 6/statement cycle withdrawal limit is waived during the coronavirus outbreak under Regulation D

  • Excessive transactions fee

    None

  • Overdraft fees

    N/A

  • Offer checking account?

    No

  • Offer ATM card?

    No

See our methodology, terms apply.

Pros

  • No minimum balance (just $1 to earn interest)
  • No monthly fees
  • Up to 6 free withdrawals or transfers per statement cycle*
  • Easy-to-use mobile banking app
  • Offers no-fee personal loans

Cons

  • No option to add a checking account
  • No ATM access
  • You can't deposit a check via the mobile app

For a higher APY, the Varo Savings Account is a good option.

Varo stands out because of its unique, tiered APY program that lets you earn up to 2.80% APY if you meet certain monthly requirements: Account holders must make a minimum of five purchases using their Varo Visa® Debit Card, have direct deposits totaling $1,000 or more each month and keep a savings account balance no higher than $10,000 (there is no minimum balance) all in the same month.

Varo Savings Account

Varo Savings Account
Information about the Varo Savings Account has been collected independently by CNBC and has not been reviewed or provided by the bank prior to publication. Bank Account Services are provided by The Bancorp Bank, Member FDIC.
  • Annual Percentage Yield (APY)

    0.81% (with option to earn up to 2.80% if meet requirements)

  • Minimum balance

    None

  • Monthly fee

    None

  • Maximum transactions

    Up to 6 free withdrawals or transfers per statement cycle *The 6/statement cycle withdrawal limit is waived during the coronavirus outbreak under Regulation D

  • Excessive transactions fee

    None

  • Overdraft fees

    None up to $50; anything greater, Varo would decline the transaction

  • Offer checking account?

    Yes

  • Offer ATM card?

    Yes, if have a Varo checking account

See our methodology, terms apply.

Pros

  • High APY and option to earn even higher
  • No minimum balance
  • No monthly fees
  • Up to 6 free withdrawals or transfers per statement cycle*
  • No penalty for overdrafts up to $50 (anything greater, Varo declines the transaction)
  • Option to add a checking account
  • ATM access if you have a checking account
  • Offers 2 programs to help automate your savings

Cons

  • Overdrafts over $50 will cause transactions to be declined
  • Cash deposits are only available through third-party services, which may charge a fee
Editorial Note: Opinions, analyses, reviews or recommendations expressed in this article are those of the CNBC Select editorial staff’s alone, and have not been reviewed, approved or otherwise endorsed by any third party.