Fundamental mortgage Q&A: “How does mortgage 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 mortgage term. And possibly even a new balance.

You may elect to receive this new mortgage from the same bank that held your old loan previously, or you may refinance your home loan with an entirely different lender.

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

Regardless, the bank or mortgage lender that ultimately grants you the new mortgage essentially pays off your old mortgage with a new mortgage, 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 cash in on equity accrued in their home.

Two Main Types of Mortgage Refinancing

There are two main types of refinancing; rate and term and cash-out.

The Terms and Rates of Refinancing 

  • See many more reasons to refinance your mortgage, some you may have never thought of.
  • Lately, a large number of homeowners have been going the rate and term refi route to take advantage of the unprecedented record low mortgage rates 
  • Many have been able to refinance into shorter-term loans like the 15-year fixed mortgage without seeing much of a monthly payment increase thanks to the sizable rate improvement.
  • 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 (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 refinancing costs are “recouped” via the lower monthly mortgage payments.
  • Put simply, a rate and term refinance is basically 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 to lower your rate and possibly shorten the term in order to save on interest.
  • In my example above, the refinancing results in a shorter-term mortgage and a substantially lower interest rate. Two birds, one stone.  It will be paid off faster and with far less interest.  Magic.
  • 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), going from an FHA loan to a conventional loan, or consolidating multiple loans into one. And in our example, to reduce the term as well (if desired).
  • 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.
  • Loan amount stays the same
  • But the interest rate is reduced
  • And/or the loan product is changed
  • Such as going from an ARM to a FRM
  • Or from a 30-year fixed to a 15-year fixed

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