When you refinance a mortgage, you pay off your existing loan and replace it with a new one. Homeowners refinance for many reasons, including:
- To lower the interest rate
- To reduce the length of their mortgage
- If you wish to convert from an adjustable-rate mortgage to a fixed-rate mortgage, or the other way around
- To raise funds from home equity for a financial emergency, to finance a large purchase or to consolidate debt
It is important for a homeowner to determine whether refinancing is a wise financial decision, particularly since refinancing can cost from 3% to 6% of a loan’s principal.
How does refinancing work?
Now that you know what is refinance mortgage, let’s have a look at how does it work. The refinancing process involves replacing your existing mortgage loan with a new one.
As you did when you bought your home, you apply for a new mortgage when you refinance. It is used to pay off your existing mortgage, not to buy a home.
If you refinance, your current mortgage debt is erased. Moreover, you can select your loan terms and interest rate, so you can save money or reach other financial goals with your new home loan.
This means you continue paying off your home loan, but you’re now paying on the new one rather than your old one.
It should be noted that you don’t actually pay off your first mortgage. That part is handled by the lender(s).
For you personally, the process of refinancing a mortgage looks very much like the one you had when you originally obtained your home loan.
Reasons to Refinance a Mortgage
Homeowners refinance their mortgage loans for a variety of reasons. Here are a few to consider:
Lower interest rate and payment.
You may be able to save money on interest by lowering your rate and monthly payment if your credit rating has improved since you got your first loan.
A home with substantial equity may be worth cashing out a portion of it to pay bills or finance a large purchase. Refinance may also allow you to buy out an ex-spouse in a divorce.
Change rate type.
Getting a fixed-rate loan can protect you from market fluctuations if your original mortgage had an adjustable rate.
Change loan term.
Shortening your loan term from 30 years to 15 or 20 years typically helps you qualify for a lower interest rate. Additionally, you can save on interest by making this decision. You can potentially lower your monthly payment if you extend your loan term.
Refinancing your mortgage loan is a very common procedure, and it has several advantages:
- You may pay more interest if you extend the loan term.
- Taking out a portion of your equity will increase your loan amount on your new mortgage, thereby increasing your monthly payment.
- The new loan does not guarantee better terms.
- You may not be able to score a lower interest rate if market rates have increased since you took out your first loan.