Mortgage Refinancing

Mortgage refinancing allows homeowners to adapt to changing financial situations. There are a number of benefits for mortgage refinancing as well as some drawbacks and considerations. Read on to learn the basics of mortgage refinancing.

What is mortgage refinancing?

Mortgage refinancing is essentially a refinancing of your mortgage loan terms. In most cases, a refinanced mortgage will terminate the original loan and give you a clean slate on a brand new mortgage loan. You can get mortgage refinancing from your current mortgage lender or a new lender.

Why should you refinance your mortgage?

Homeowners choose to refinance their mortgages because they would like to change the terms of their original mortgage loan. Because mortgage refinancing gives you a brand new loan, you can change any or all of the terms, including:

Interest Rates: The interest rate you receive on your original mortgage loan depends on your credit history, your income and assets and the federal interest rates. If any of those factors change, you can refinance for a lower interest rate. Doing so could save you in the long run.
Loan Term: Most mortgages are 30 year terms. The longer your loan, the more you will ultimately pay in interest and the lower your monthly payments will be. Mortgage refinancing allows you to extend or shorten the term of your loan in order to reduce overall costs or monthly payments according to your needs.
Type of Loan: There are numerous types of loans, each with their own advantages and disadvantages. The two main types are fixed rate and adjustable rate mortgages (ARMs). ARMs are best in high interest markets, but a fixed rate is advantageous because it allows you to lock in rates when they are low. If the federal interest rate is drastically lower than when you first closed on your original mortgage, it may be in your best interest to lock in the lower rates by refinancing or switching to a fixed rate mortgage.
Mortgage Lender: Also not to be overlooked is the mortgage lender. With a mortgage refinancing, you can switch to an entirely different institution. This may be attractive if your lender’s competitors offer better rates or if you are simply fed up with your current lender.

What is cash-out refinancing?

Cash-out mortgage refinancing refers to the practice of refinancing your home in order to get cash that can be spent towards other expenses. When you refinance a mortgage, you are essentially given a lump sum of money to pay off your old mortgage. If the amount of your new mortgage exceeds what you owe on your first mortgage, you can pocket the difference.

Here’s an example:

Let’s say you get a $100,000 30-year mortgage to pay for a home that is worth $130,000 in 2010. By 2020, you would owe about $84,000 on the loan. Now, say you would like to have $30,000 in cash to pay for college. You could refinance a new mortgage for $114,000. You would pay off the old mortgage for $84,000 and then have $30,000 leftover to spend however you’d like. Now, you have a new 30 year mortgage with a balance of $114,000.

This example only addresses the issue of refinancing for more cash on hand. But let’s say that in the 10 years since you bought the same home, your home’s value also appreciated to $150,000. Furthermore, your credit has improved by 50 points. Now that you have more home equity and a better credit rating, you can also qualify for a lower interest rate as well.

What are the advantages and disadvantages of mortgage refinancing?

The main benefit of mortgage refinancing is that it allows flexibility. You can respond to changes in the economy or in your employment status, financial goals or family expenses. Mortgage refinancing also opens the doors to long term investments. Because mortgage interest rates are almost always lower than personal loans and credit card debt, cash-out mortgage refinancing makes sense when it comes to paying for debt consolidation, education and improvements on your home. Beyond cashing out on your home equity, you refinancing a mortgage at the right time can also save you thousands of dollars in the long run by locking in low interest rates.

On the flip side, mortgage refinancing can actually cost you money if you are not careful. Mortgage refinancing comes with all the costs associated with getting a new loan. That includes origination fees, home appraisals and other costs. Furthermore, your original mortgage lender may charge you an early payment fee.

It is also important that you use mortgage refinancing for long term goals, rather than short term indulgences. Refinanced mortgages saddle you with debt that you’ll be paying interest on for 30 years or more. Although mortgage interest rates are lower than other forms of debt, the longer you accumulate interest, the more you’ll pay in the end. For this reason, it may be more economical to get a higher interest rate loan - such as a second mortgage or a home equity line of credit - for a shorter period of time.

How do I refinance my home?

Obtaining mortgage refinancing is done in much the same way as getting your original home loan. The main difference is that you will have to look into how to get out of your original mortgage loan. Read through your lender’s terms carefully to see if you are able to pay off your original mortgage without penalties. Then, begin looking for a new mortgage lender as you would for any other type of mortgage. If you are satisfied with your current mortgage lender, you can refinance your loan through them. But if you are unhappy with your relationship with your lender, now would be a good time to choose a mortgage lender that meets your needs.

Conclusion

Mortgage refinancing allows you to take advantage of low interest rates and adjust to unforeseen financial circumstances. As with all major financial moves, it pays to take a long view before moving forward with a mortgage refinancing. Due to the upfront costs of mortgage refinancing, it is best to refinance strategically once rather than continually chasing down lower rates and better terms. For more tips on when to refinance and how to benefit the most from mortgage refinancing, read some of our recent blog posts on the topic: What type of loan provides low interest debt consolidation?
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