How Does Mortgage Refinancing Work?

Refinancing your mortgage is just like starting all over with a new mortgage, but things may be different this time around. First of all, you might be financing a smaller amount because you have already paid off a lot of the original mortgage. Or, you might be financing more because your house is now worth more and you want to take out some of that equity. Then your interest rate may be different. You might be switching from an adjustable rate mortgage to a fixed rate or visa versa. And you might be financing for a longer or shorter time period. All these variables can be changed depending on what you want and what the lender will agree to.

For example, let’s assume you have 21 years left on your adjustable rate mortgage and your rate just went up. You notice that the fixed rates are lower, and you would like to lock in the new lower rates. Your lender might agree to a refinanced mortgage at the new lower fixed rate for 15 or 30 years. You have to pay closing costs, but you should recoup these costs if you stay in the house a few years. Over the term of the mortgage you should save a lot in interest. The longer you own the home, the more you save in interest costs.

Another example: let’s assume you have 18 years left on you fixed rate mortgage and have considerable equity in your home. You also have about $20,000 in credit card debt which you have foolishly piled up over the years. The credit card interest is really expensive and you want to get out from under that burden. (And you promise yourself never to go into that kind of debt again.) You can get the cash by refinancing your home. Maybe your lender will agree to refinance your mortgage over 30 years and return about $20,000 in home equity to you. You use the money to pay off the credit card debt and save a bundle in interest expense. Since you have extended the length of your mortgage your payment may even be lower. You will have to pay closing costs, and the lender can foreclose on your house if you can’t make your payment.

Mortgage refinancing can be a useful financial tool when used carefully.