Chapter 3: Refinancing

Refinancing is the process of paying off the existing mortgage(s) with the proceeds from a new loan and using the same property as collateral. Refinancing can be done with your current lender, or a different one. The interest rate that you can get when refinancing is often lower than what you can get with a second mortgage, but this does not always hold true. Refinancing is done for a variety of reasons.

Refinancing to reduce the interest rate
Interest rates constantly fluctuate, and many homeowners refinance their mortgages because the rates they can get today are better than the ones they received when they first got their loans. A reduced interest rate provides the benefit of lowering the monthly payment, which puts more cash in your pocket.

Even if you do get a lower interest rate, refinancing does not always save you money. Refinancing is not a free process – a new loan means you will have to pay most of the same closing costs you paid the first time around. Let’s say refinancing to a lower interest rate saves you $1,000 a year in interest, and you have to pay $5,000 in closing costs. If you sell the house after a year, refinancing will have actually cost you $4,000! Generally, the longer you are planning to stay in the house, the more beneficial refinancing to a lower interest rate is. You can use the calculator below to see if refinancing will save you money.

Refinancing to lower the payments
For those that are struggling, refinancing can be a way to improve cash flow (although refinancing alone is not always enough). The conditions under which you may be able to lower your payments through refinancing include:

• Getting a lower interest rate. As discussed above, if you get a lower interest rate, your monthly payments will decrease, since you do not have to pay as much in interest.

• Extending the repayment period. Maybe you have a 15-year mortgage and want to switch it for a 30-year loan, or you want to refinance your 10-year home equity loan into a 30-year mortgage. When you pay the same amount over a longer period of time, the monthly payments are lower, although the total amount shelled out for interest is greater.

• Refinancing for less than what was initially borrowed. All other things being equal, the lower the loan amount, the lower the monthly payment. For example, if you took out a standard 30-year mortgage for $200,000 at 6%, your monthly payments would be $1,199.10. After ten years, the balance would be $167,371.62. If you refinanced the remaining balance with another 30-year, 6% mortgage, the monthly payment would be $1,003.48, a monthly savings of almost $200! However, doing this does increase the total amount of interest paid.

Refinancing to get cash out
With a cash-out refinance, you refinance your existing mortgage and also borrow an additional sum from your equity at the same time, giving you cash that you can use for whatever you want. This is the only type of refinance where you actually use your home equity. You may be able to combine a cash-out refinance with getting a lower payment or interest rate, but if you do not take cash out, your equity does not change.

Depending on your new interest rate and how much cash you take out, it is possible that your mortgage payments will increase. You can use the loan calculator below to estimate what your new payments would be if you refinanced. You should carefully consider if you can handle the increase in payments.

How much you can refinance for depends on the value of your house and the lender’s maximum allowed loan-to-value (LTV) ratio. The LTV ratio is the percentage of the home’s value that is financed. For example, if the lender has a maximum 95% LTV ratio, you can borrow up to 95% of the home’s value. Some lenders may let you refinance up to 100% of the value, but you may have to pay for private mortgage insurance until you rebuild 20% equity.