A mortgage refinance refers to the process of taking out a new loan to pay off the original loan. An additional loan may sound like an additional financial burden, but it isn't. In fact, there are several advantages of refinancing, which is why many homeowners prefer a mortgage refinance.
If you want to understand mortgage refinancing in detail, you're in the right place.
How does refinancing a mortgage work?
To refinance your mortgage, you need to follow similar steps as you did when you obtained your original mortgage. Start by checking whether or not you qualify for a new loan. If you do, the next step is to shortlist a few mortgage lenders and compare interest rates and other terms across lenders. Pick the one with the best offer and compare it with the term of your existing mortgage.
With a refinance, your new loan will have a new interest rate and terms. If your credit score has improved since you applied for your original loan, the new loan will likely come with favorable interest rates and terms. Another great thing is that your refinance loan can be from any lender, which means you're not obligated to go back to your first lender for refinancing.
Once you've finalized your new lender, the following steps include filing a loan application, going through the underwriting process, and closing on your new loan.
Benefits of mortgage refinancing
Homeowners choose to refinance their mortgages for a variety of reasons. Here are the top benefits of refinancing you must know about:
- Lower interest rate and monthly payments
In most cases, this is the primary reason for refinancing. Typically, if your credit score has improved, or if the mortgage rates in the market have dropped since you got your first loan, your new loan will have lower interest rates and monthly payments.
- Modify loan term
Another advantage of refinancing is that you can increase or decrease your loan term. If you want to pay off your loan faster, you can reduce the term of your loan, which translates to less interest over the life of the loan. However, your monthly payments may rise. On the other hand, if you want to lower your monthly payment further, you can extend your loan term. But that means you will pay more interest in the long run.
- Change rate type
Interest rates on an adjustable-rate mortgage tend to fluctuate and go up over time. If your first mortgage has an adjustable rate, it's advisable to switch to a fixed-rate mortgage, which is immune to market fluctuations. In other words, you will pay the same interest throughout your loan term with fixed-rate mortgages.
- Cash-out the equity
If there is considerable equity built up in your home, you may be able to cash out a portion of the equity. You're free to use this money the way you want, be it paying bills, remodeling your home, or sending your child to college.
Types of mortgage refinancing
In general, you can choose from one of the three types of mortgage refinancing options. These types include:
- Rate-and-term refinance
In this type of refinancing, the aim is to change the interest rate of the loan or the term of the loan, or both, without modifying the principal amount of the loan. Doing this can help lower your monthly payments or save money on interest. Typically, to reduce the amount you owe, you will need to pay some closing costs for your new loan.
- Cash-out refinance
This involves taking a portion of the equity in your home and turning it into cash on hand. Although this increases your mortgage debt, it provides you the capital that you can use to remodel your home, pay bills, or anything else. With cash-out refinance, you can also get a new loan term and interest rate.
- Cash-in refinance
In this type of refinancing, homeowners not only refinance their mortgage loans but also put in more money to lower their new mortgage balance. It's usually a great option for people who want to qualify for a lower interest rate loan or bring a mortgage amount below a certain value.