What Does Refinance Mean on a Mortgage?

Mortgage refinancing can be beneficial for people who want a lower interest rate or to cash out their home’s equity. However, before you think about refinancing your mortgage, let’s take a deeper look into what mortgage refinancing is and the types of refinance options you can choose from!

What Is Mortgage Refinancing?

Refinancing a mortgage is replacing your current mortgage loan with a new one. Mortgage refinancing involves using the money of the new loan to pay off your previous mortgage balance. It can help you save some capital or meet a specific financial goal.

For instance, many individuals refinance to decrease their interest rates and reduce their overall mortgage payments, saving thousands along the way. Others refinance for a different loan term, such as moving from a 30-year to a 15-year plan. Refinancing also enables you to cash out your home’s equity.

How Does Mortgage Refinancing Work?

When you apply for a mortgage refinance, a lender will review your finances to evaluate your eligibility for a more favorable interest rate. You can choose the same lender you chose for your original loan or work with a different lender. 

Refinancing a mortgage will reset your repayment timeline. For instance, if you have paid five years’ worth of repayments on a 30-year plan (you have 25 years of repayments left) and shift to a 15-year plan, you will have to pay for 15 years until you have completely paid off the new amount. However, if you opt for another 30-year plan, you will have to start anew and pay off the amount for another 30 years.

Refinancing also comes with closing costs ranging from 2% to 5% of the refinance. These costs include an origination fee, discount points, and an appraisal fee. You will need to calculate your break even point to decide whether you will live in your current home long enough to recover the closing costs and benefit from the refinance savings. 

What Are the Common Types of Mortgage Refinancing? 

Here are some common types of mortgage refinances:

Rate-and-Term Refinance

It involves replacing your existing mortgage with a new loan term with changed monthly payments and interest rates. USDA, VA, FHA, and conventional mortgages are eligible for rate-and-term financing. To qualify for this mortgage refinance, you will need a good credit score, considerable home equity, and a certain debt-to-income ratio. 

Cash-Out Refinance

It involves replacing your existing mortgage with a new loan that is larger than the amount you have yet to pay on the house so that you can receive the extra amount in cash. VA, FHA, and conventional mortgages are eligible for cash-out refinancing.

 It’s an excellent option for people who have built their home equity since most lenders will not let you take out more than 80% of your home’s value in cash, requiring you to keep at least 20% equity. 

For instance, if your house is valued at $100,000, and you have $50,000 left to pay on the initial mortgage, you have $50,000 equity or 50% of the home value. If you need to keep 20% equity, you will be eligible to take out 30% of the value, i.e., $30,000. So, you will take out a loan of $80,000 –of which $50,000 you owe to the lender and $30,000 you can take out in cash. 

Cash-In Refinance

A cash-in refinance involves paying a lump sum to reduce your loan-to-value ratio, decreasing your overall debt burden and lowering your monthly payments. The lender replaces your mortgage with a loan with a smaller principal balance. Before using your savings for cash-in mortgage refinancing, ensure it will benefit you in the long run.

Short Refinance

If you cannot make your mortgage payments and are risking foreclosure, your lender might offer you a loan lower than the original loan and forgive the difference. It will keep you safe from foreclosure but negatively impact your credit score. 

No-Closing-Cost Refinance

As the name suggests, it enables you to refinance your mortgage without paying upfront closing costs. These costs get rolled into your loan, resulting in higher monthly payments and interest rates. It is ideal for people who do not plan to stay in their home for a long time, as you will sell the house before paying thousands more in interest.