How Does Refinancing Work?
More fundamental mortgage Q&A: “How does refinancing work?”
When you refinance your mortgage, you are essentially trading in your old loan for a fresh one with a new interest rate and set of terms.
You may elect to receive a new mortgage from the same bank that held your old loan previously, or possibly refinance your loan with a new lender.
The bank or lender who grants you the new mortgage essentially pays off your old mortgage, thus the term refinancing.
In a nutshell, most borrowers choose to refinance their mortgage either to take advantage of lower interest rates, consolidate high-interest rate debt, or to cash in on equity accrued in the home.
There are two main types of refinances; rate and term refinancing and cash-out refinancing (click the links to get in-depth explanations of both).
To put it simply, a rate and term refinance is basically trading in your old mortgage(s) for a new shiny one without raising the loan amount by any extraordinary amount, usually the lesser of two percent of the new mortgage amount or $2,000.
Reasons for carrying out this type of refinancing include securing a lower interest rate, moving out of an adjustable-rate mortgage into a fixed-rate mortgage (or vice versa), or consolidating multiple loans into one.
Lately, a large number of homeowners have been carrying out rate and term refis to take advantage of the record low rates.
Obviously, it has to make sense to the borrower to execute this type of transaction, as you won’t be getting any cash in your pocket for doing it, but you will be paying closing costs and other fees that must be considered.
On the other hand, a cash-out refinance involves exchanging your old loan for a larger mortgage.
This type of refinancing allows homeowners to tap into the equity in their homes, the value of the property minus any existing mortgages or liens.
Cash out refinancing puts money in the pockets of homeowners, but can be a drawback because you’re left with a larger balance to pay back as a result (and there also the closing costs).
Many homeowners who serially refinanced over the past decade have found themselves underwater, or owing more on their mortgage than the home is currently worth, despite buying properties on the cheap years ago.
An alternative to refinancing your existing loan is taking out a second mortgage, or a home equity line of credit.
This keeps the first mortgage intact if you’re happy with the related rate and terms, but gives you the power to tap into your equity when necessary.
