How Does Mortgage Refinancing Work?

Trade
In
Your
Old
Home
Loan
for
a
New
One

Fundamental
mortgage
Q&A:
“How
does
mortgage
refinancing
work?”

When
you
refinance
a
mortgage,
you
trade
in
your
old
home
loan
for
a
new
one
in
order
to
get
a
lower
interest
rate,
cash
out
of
your
home,
and/or
to
switch
loan
programs.

In
the
process,
you’ll
also
wind
up
with
a
new

mortgage
term,
and
possibly
even
a
new
loan
balance
if
you
elect
to
tap
into
your
home
equity.

You
may
choose
to
obtain
this
new
mortgage
from
the
same
bank
(or

loan
servicer)
that
held
your
old
loan,
or
you
may
refinance
your
home
loan
with
an
entirely
different
lender.
That
choice
is
up
to
you.

It’s
certainly
worth
your
while
to
shop
around
if
you’re
thinking
about
refinancing
your
mortgage,
as
your
current
lender
may
not
offer
the
best
deal.

I’ve
seen
first-hand
lenders
try
to
talk
their
existing
customers
out
of
a
refinance
simply
because
there
wasn’t
an
incentive
for

them.
So
be
careful
when
dealing
with
your
current
lender/servicer.

Anyway,
the
bank
or

mortgage
lender
that
funds
your
new
mortgage
pays
off
your
old
loan
balance
with
the
proceeds
from
the
new
loan,
thus
the
term

refinancing.
You
are
basically

redoing
your
loan.

In
a
nutshell,
most
borrowers
choose
to
refinance
their

mortgage
either
to
take
advantage
of
lower
interest
rates
or
to
access
equity
they’ve
accrued
in
their
home.

Two
Main
Types
of
Mortgage
Refinancing

As
noted,
a
mortgage
refinance
is
essentially
a
trade-in
of
your
existing
home
loan
for
a
new
one.
You
are
under
no
obligation
to
keep
your
loan
for
the
full
term
or
anywhere
near
it.

Don’t
like
your
mortgage?
Simply
refi
it
and
get
a
new
one,
simple
as
that.
And
by
simple,
I
mean

qualifying
for
a
mortgage
again
and
going
through
a
very
similar
process
to
that
of
obtaining
a
home
purchase
loan.

You
can
check
out
my
article
about

the
mortgage
refinance
process
to
see
how
it
works,
step-by-step.

It’ll
take
about
a
month
to
six
weeks
and
will
feel
very
much
like
it
did
when
you
purchased
a
home
with
a
mortgage.

You’ll
typically
need
to
provide
income,
asset,
and
employment
information
to
the
new
lender.
And
they
will
pull
your
credit
report
to
determine
creditworthiness,
along
with
ordering
an
appraisal
(if
necessary).

Now
assuming
you
move
forward,
there
are
two
main
types
of
refinancing
options;

rate
and
term
and

cash-out
(click
the
links
to
get
in-depth
explanations
of
both
or
continue
on
reading
here).

Rate
and
Term
Refinancing

Loan
amount
stays
the
same
But
the
interest
rate
is
typically
reduced
And/or
the
loan
product
is
changed
Such
as
going
from
an
ARM
to
a
fixed-rate
mortgage
Or
from
a
30-year
fixed
to
a
15-year
fixed
loan
Or
FHA
to
conventional
You
obtain
a
new
interest
rate
and
loan
term
(even
a
fresh
30
years
if
wanted)

Let’s
start
with
the
most
basic
type
of
mortgage
refinance,
the
rate
and
term
refinance.

If
you
don’t
want
any
cash
out,
you’ll
simply
be
looking
to
lower
your
interest
rate
and
possibly
adjust
the
term
(duration)
of
your
existing
loan.

This
type
of
transaction
is
also
known
as
a
limited
cash-out
refinance
or
a
no
cash-out
refinance.

The
takeaway
is
that
your
loan
amount
stays
basically
the
same,
but
your
financing
terms
change.

Let’s
look
at
an
example:

Original
mortgage:
$300,000
loan
balance,
30-year
fixed
@

6.50%
New
mortgage:
$270,000
loan
amount,
15-year
fixed
@

4.50%

Simply
put,
a
rate
and
term
refinance
is
the
act
of
trading
in
your
old
mortgage(s)
for
a
new
shiny
one
without
raising
the
loan
amount.

As
noted,
the
motivation
to
do
this
is
typically
to
lower
your
interest
rate
and
possibly
shorten
the
term
in
order
to
save
on
interest.

Or
to
change
products,
such
as
moving
from
an
adjustable-rate
mortgage
to
a
more
secure
fixed-rate
mortgage.

In
my
example
above,
the
refinance
results
in
a
shorter-term
mortgage
and
a
substantially
lower
interest
rate.
Two
birds,
one
stone.

And
the
loan
amount
is
smaller
because
you
may
have
taken
out
the
original
loan
seven
years
ago.
So
we
need
to
account
for
principal
pay
down
between
the
date
of
origination
and
the
time
of
refinance.

In
any
case,
thanks
to
the
lower
rate
and
shorter
loan
term,
it
will
be
paid
off
faster
than
scheduled
and
with
far
less
interest.
Magic.

Here’s
a
more
in-depth
example
with
monthly
payments
included:

Original
loan
amount:
$300,000
(outstanding
balance
$270,000
after
seven
years)

Existing
mortgage
rate:
6.5%
30-year
fixed

Existing
mortgage
payment:
$1,896.20

New
mortgage
rate:
4.5%
15-year
fixed

New
mortgage
payment:
$2,065.48

In
this
scenario,
your
new
loan
amount
will
be
whatever
the
loan
was
paid
down
to
prior
to
the
refinance.
In
this
case
it
was
originally
$300,000,
but
paid
down
to
$270,000
over
seven
years.

You’ll
also
notice
that
your
interest
rate
drops
two
percentage
points
and
your
mortgage
term
is
reduced
from
30
years
to
15
years
(you
could
go
with
another
30-year
loan
term
if
you
chose).

As
a
result
of
the
refinance,
your
monthly
mortgage
payment
increases
nearly
$170.

While
this
may
seem
like
bad
news,
it’ll
mean
much
less
will
be
paid
in
interest
over
the
shorter
term
and
the
mortgage
will
be
paid
off
a
lot
quicker.
We’re
talking
22
years
instead
of
30.

If
the
timing
is
right,
it
might
be
possible
to
shorten
your
loan
term
and
reduce
your
monthly
payment!

Consider
the
Loan
Term
When
Refinancing

For
those
who
don’t
want
a
mortgage
hanging
over
their
head
for
30
years,
the
use
of
a
rate
and
term
refinance
illustrated
above
can
be
a
good
strategy.

Especially
since
the
big
difference
in
interest
rate
barely
increases
the
monthly
payment.

But
you
don’t
need
to
reduce
your
loan
term
to
take
advantage
of
a
rate
and
term
refinance.

You
can
simply
refinance
from
one
30-year
fixed
into
another
30-year
fixed,
or
from
an
adjustable-rate
mortgage
into
a
fixed
mortgage
to
avoid
an
upcoming
rate
adjustment.

Some
lenders
will
also
let
you
keep
your
existing
term,
so
if
you’re
three
years
into
a
30-year
fixed,
you
can
get
a
new
mortgage
with
a
27-year
term.
You
don’t
skip
a
beat,
but
your
payment
drops.

If
you
go
with
another
30-year
loan
term,

the
refinance
will
generally
serve
to
lower
monthly
payments,
which
is
also
a
common
reason
to
refinance
a
mortgage.

Many
homeowners
will
refinance
so
they
can
pay
less
each
month
if
they’re
short
on
funds,
or
wish
to
put
their
money
to
work
elsewhere,
such
as
in
another,
higher-yielding
investment.

So
there
are
plenty
of
options
here
–
just
be
sure
you’re
actually
saving
money
by
refinancing,
as
the
closing
costs
can
eclipse
the
savings
if
you’re
not
careful.

A
Mortgage
Refinance
Isn’t
Always
About
the
Interest
Rate

As
you
can
see,
reasons
for
carrying
out
this
type
of
refinancing
are
plentiful.

While
securing
a
lower
interest
rate
may
be
the
most
common,
there
can
be
other
motivations.

They
include
moving
out
of
an

adjustable-rate
mortgage
into
a

fixed-rate
mortgage
(or
vice
versa),

going
from
an
FHA
loan
to
a
conventional
loan,
or
consolidating
multiple
loans
into
one.

And
in
our
example
above,
to
reduce
the
loan
term
as
well
(if
desired)
in
order
to
pay
down
the
loan
faster.

See
many
more

reasons
to
refinance
your
mortgage,
some
you
may
have
never
thought
of.

In
recent
years,
a
large
number
of
homeowners
went
the
rate
and
term
refi
route
to
take
advantage
of
the
unprecedented

record
low
mortgage
rates
available.

Many
were
able
to
refinance
into
shorter-term
loans
like
the

15-year
fixed
mortgage
without
seeing
much
of
a
monthly
payment
increase
(or
even
a
decrease)
thanks
to
the
sizable
interest
rate
improvement.

Obviously,
it
has
to
make
sense
as
you
won’t
be
getting
any
cash
in
your
pocket
(directly)
for
doing
it,
but
you
will

pay
closing
costs
and
other
fees
that
must
be
considered.

So
be
sure
to

find
your
break-even
point
before
deciding
to
refinance
your
existing
mortgage
rate.
This
is
essentially
when
the
upfront
refinancing
costs
are
“recouped”
via
the
lower
monthly

mortgage
payments.

If
you
don’t
plan
on
staying
in
the
home/mortgage
for
the
long-haul,
you
could
be
throwing
away
money
by
refinancing,
even
if
the
interest
rate
is
significantly
lower.

[How
quickly
can
I
refinance?]

Cash-Out
Refinancing

The
loan
amount
is
increased
as
a
result
of
home
equity
being
tapped
The
funds
can
be
used
for
any
purpose
you
wish
once
the
loan
closes
May
also
result
in
a
lower
interest
rate
and/or
product
change
But
monthly
payment
could
increase
thanks
to
the
larger
loan
amount
You
may
also
choose
a
new
loan
term
(e.g.
15
or
30
years)

Original
mortgage:

$300,000
loan
balance,
30-year
fixed
@6.25%
New
mortgage:

$350,000
loan
amount,
30-year
fixed
@4.75%

Now
let’s
discuss
a
cash-out
refinance,
which
involves
exchanging
your
existing
home
loan
for
a
larger
mortgage
in
order
to
get
cold
hard
cash.

This
type
of
refinancing
allows
homeowners
to
tap
into
their

home
equity,
assuming
they
have
some,
which
is
the
value
of
the
property
less
any
existing
mortgage
balances.

Let’s
pretend
the
borrower
from
my
example
has
a
home
that
is
now
worth
$437,500,
thanks
to
healthy
home
price
appreciation
over
the
years.

If
their
outstanding
loan
balance
was
$300,000,
they
could
pull
out
an
additional
$50,000
and
stay
below
that
all-important

80%
loan-to-value
(LTV)
threshold.

The
cash
out
amount
is
simply
added
to
the
existing
loan
balance
of
$300,000,
giving
them
a
new
loan
balance
of
$350,000.

What’s
really
cool
is
the
mortgage
payment
would
actually
go
down
by
about
$25
in
the
process
because
of
the
large
improvement
in
interest
rates.

So
even
though
the
borrower
took
on
more
debt
via
the
refinance,
they’d
actually
save
money
each
month
relative
to
their
old
loan
payment.

Now
a
more
in-depth
example:

Loan
amount:
$200,000

Existing
mortgage
rate:
6.5%
30-year
fixed

Existing
mortgage
payment:
$1,264.14

Cash
out
amount:
$50,000

New
loan
amount:
$250,000

New
mortgage
rate:
4.25%
30-year
fixed

New
mortgage
payment:
$
1,229.85

In
this
scenario,
you’d
refinance
from
a
30-year
fixed
into
another
30-year
fixed,
but
you’d
lower
your
mortgage
rate
significantly
and
get
$50,000
cash
in
your
pocket
(less
closing
costs).

At
the
same
time,
your
monthly
mortgage
payment
would
actually
fall
$35
because
your
former
interest
rate
was
so
high
relative
to
current
mortgage
rates.

While
this
all
sounds
like
good
news,
you’ll
be
stuck
with
a
larger
mortgage
balance
and
a
fresh
30-year
term
on
your
mortgage.

You
basically

restart
the
clock
on
your
mortgage
and
are
back
to
square
one.

Cash
Out
Will
Typically
Slow
Loan
Repayment

If
you’re
looking
to
pay
off
your
mortgage
in
full
some
day
soon,
the
cash
out
refi
probably
isn’t
the
best
move.

But
if
you
need
cash
for
something,
whether
it’s
for
an
investment
or
to
pay
off
other
more
expensive
debt,
it
could
be
a
worthwhile
decision.

In
short,
cash
out
refinancing
puts
money
in
the
pockets
of
homeowners,
but
has
its
drawbacks
because
you’re
left
with
a
larger
outstanding
balance
to
pay
back
as
a
result
(and
there
are
also
the
closing
costs,
unless
it’s
a

no
cost
refi).

While
you
wind
up
with
cash,
you
typically
get
handed
a
more
expensive
monthly
mortgage
payment
unless
your
old
interest
rate
was
super
high.

In
our
example,
the
monthly
payment
actually
goes
down
thanks
to
the
substantial
rate
drop,
and
the
homeowner
gets
$50,000
to
do
with
as
they
please.

While
that
may
sound
great,
many
homeowners
who
serially
refinanced
in
the
early
2000s
found
themselves

underwater
on
the
mortgage,
or
owing
more
on
their
loan
than
the
home
was
worth,
despite
buying
properties
on
the
cheap
years
earlier.

This
is
why
you
have
to
practice
caution
and
moderation.
For
example,
a
homeowner
might
pull
cash
out
and
refinance
into
an
ARM,
only
for
home
prices
to
drop
and
zap
their
remaining
equity,
leaving
them
with
no
option
to
refinance
again
if
and
when
the
ARM
adjusts
higher.

Simply
put,
if
you
pull
cash
out
it
has
be
paid
back
at
some
point.
And
it’s
not
free
money.
You
must
pay
interest
and
closing
costs
so
make
sure
you
have
a
good
use
for
it.

How
Are
Refinance
Mortgage
Rates?

If
your
transaction
is
simply
a
rate
and
term
refinance
it
should
be
priced
similarly
to
that
of
a
home
purchase
loan
The
only
difference
might
be
slightly
higher
closing
costs
(though
some
banks
do
advertise
lower
rates
on
purchases)
If
you
request
cash
out
with
your
refinance
additional
pricing
adjustments
will
likely
apply
These
could
increase
your
interest
rate,
perhaps
substantially

Now
let’s
talk
about

refinance
mortgage
rates
for
a
moment.
When
filling
out
a
loan
application
or
a
lead
form,
you’ll
be
asked
if
it’s
a
purchase
or
a
refinance.
And
if
it’s
the
latter,
if
you
want
additional
cash
out.

For
most
lenders,
a
home
purchase
and
rate
and
term
refinance
will
be
treated
the
same
in
terms
of
interest
rates.

There
shouldn’t
be
additional
pricing
adjustments
just
because
it’s
a
refinance,
though
closing
costs

could
be
slightly
higher.

Arguably,
refinances
could
be
viewed
as
less
risky
than
home
purchase
loans
because
they
involve
existing
homeowners
who
are
typically
lowering
their
monthly
payments
or
switching
from
an
ARM
to
a
fixed-rate
loan
product.

Don’t
expect
a
discount
though.
Just
be
happy
there
isn’t
an
add-on
cost
for
it
not
being
a
purchase.
And
know
that
some
big
banks
tend
to
charge
more
for
refis.

When
it
comes
to
cash-out
refinances,
there
are
typically
additional
pricing
adjustments
that
increase
the
interest
rate
you
will
ultimately
receive.

This
means
instead
of
receiving
a
6.25%
mortgage
rate,
you
may
be
stuck
with
a
rate
of
7%
or
higher
depending
on
the
loan
scenario.

If
you
have
a
low
credit
score,
a
high
loan-to-value
ratio
(LTV),
and
want
cash
out,
your
mortgage
rate
could
skyrocket,
as
the
pricing
adjustments
are
quite
hefty
with
that
risky
combination.

In
addition,
qualifying
for
a
cash-out
refinance
will
be
more
difficult
because
the
larger
loan
amount
will
raise
your
LTV
and
put
increased
pressure
on
your

debt-to-income
ratio.

In
summary,
be
sure
to
do
the
math
and
plenty
of
shopping
around
to
determine
which
type
of
refinance
is
best
for
you.

Refinancing
Your
Mortgage
May
Not
Be
Necessary

It’s
not
always
the
right
move
depending
on
your
current
situation
And
your
future
plans
(if
you
plan
on
selling
your
home
relatively
soon)
It
can
also
reset
the
clock
on
your
mortgage
payoff
and
slow
down
repayment
So
be
sure
it
makes
sense
before
you
spend
any
time
or
money
on
it

Despite
what
the
banks
and
lenders
might
be
chirping
about,
refinancing

isn’t
always
the
winning
move
for
everyone.

In
fact,
it
could
actually
cost
you
money
if
you
don’t
take
the
time
to
crunch
the
numbers
and
map
out
a
plan.

If
you’re
not
sure
you’ll
still
be
in
your
home
next
year,
or
even
just
a
few
years
from
now,
a
refinance
might
not
make
sense
financially
if
you
don’t
recoup
the
associated
closing
costs.

This
is
especially
true
if
you

decide
to
pay
mortgage
points
at
closing,
which
can
amount
to
thousands
of
dollars.

Instead
of
borrowing
more
than
you
need,
or
adding
years
to
your
loan
term,
do
the
math
first
to
determine
the
best
move
for
your
unique
situation.

My

refinance
calculator
might
be
helpful
in
determining
what
makes
sense
depending
on
the
scenario
in
question.

One

alternative
to
refinancing
your
existing
home
loan,
especially
if
you
already
have
a
low
rate,
is
to
take
out
a

second
mortgage,
often
in
the
form
of
a

home
equity
loan
or

home
equity
line
of
credit.

This
keeps
the
first
mortgage
intact
if
you’re
happy
with
the
associated
interest
rate
and
loan
term,
but
gives
you
the
power
to
tap
into
your
home
equity
(get
cash)
if
and
when
necessary.

But
as
we
saw
in
my
example
above,
it’s
sometimes
possible
to
get
a
lower
mortgage
payment
and
cash
out
at
the
same
time,
which
is
hard
to
beat.
Just
remember
to
factor
in
the
cost
of
the
refinance.

How Does Mortgage Refinancing Work?

Trade In Your Old Home Loan for a New One

Two Main Types of Mortgage Refinancing

Rate and Term Refinancing

Consider the Loan Term When Refinancing

A Mortgage Refinance Isn’t Always About the Interest Rate

Cash-Out Refinancing

Cash Out Will Typically Slow Loan Repayment

How Are Refinance Mortgage Rates?

Refinancing Your Mortgage May Not Be Necessary