Mortgage Refinance

A mortgage is essentially a loan to purchase a house or real estate, for which the borrower pledges the same property as a security for the repayment of the loan. The borrower retains ownership, but gives the lender a lien on the property as collateral for the loan. If the borrower defaults on payment of the loan, the lender can foreclose, i.e. sell the property to recover the mortgage loan.

Mortgages usually have a life term of 30, 20 or 15 years. There are different types of mortgage loans like the fixed-mortgage rate interest loan, adjustable mortgage rate interest loan and the balloon mortgage loan.

Mortgage refinance means to avail financing through a new mortgage loan to pay off an existing mortgage loan.

Refinancing your home means obtaining a new mortgage loan to pay off the existing mortgage on your home. If the original mortgage was a fixed rate interest, and if interest rates have declined, then refinancing gives you the option of obtaining a new loan with favorable interest rates. Refinancing is of two types a straight refinance and cash out refinance.

Benefits of Mortgage Refinancing

A home is the single most expensive asset you have and a mortgage is the largest debt you can incur spread over a considerable period of time. When you refinance your home you can take advantage of the equity the house has built up.

While purchasing a home, the current financial markets determine the interest rates. The down payment you make and your credit ratings also are deciding factors. However interest rates fluctuate and when Federal Reserve reduces interest rates, perhaps the interest rates may become significantly lower than when you purchased your house. This is where refinancing is a good option, by refinancing your mortgage when interest rates are lower, you can exchange a high interest loan for a low interest one which will reduce your monthly payments.

Tom and Danielle Condon of Asheville, North Carolina refinanced twice within three months in 2005. In the August of 2005 they reduced the interest rate on their 30-year fixed rate loan a full point from 9.19% to 8.19% to gain an annual saving of $897.

As Tom says " We now have a cash emergency fund thanks to refinancing our mortgage a second time"

Similarly you can exchange an ARM for a fixed rate mortgage when interest rates are low, so you can have the security that monthly payments will remain stable inspite of fickle market conditions.

It is important also to determine if the amount saved on interest balances the fees payable during refinancing.

For example Bill and Tina Wilson exchanged their ARM for a fixed rate loan, to gain $34,000 hereby increasing their loan amount from $106,000 to $140,000. They used $3000 of their gain to pay for their refinancing costs, $17,000 to pay off a 10% home equity loan that was putting them back by $250 per month. The remaining $14,000 they used to build a garage for Bill's boat that greatly enhanced the equity of their home and all this for just another $190 a month.

A possible advantage of mortage refinancing is that you can reduce your term of the mortgage. For example if you had a 30-yr. mortgage and have abided by your amortization schedule for say, 8 years. By mortgage refinance you can shorten your term to 10, 15 or 20 years, thereby saving thousands of dollars in interest payments.

Since refinance makes sense only when interest rates are lower than when you purchased, the lowered interest rates combined with the same monthly payments as before help you to build up equity in your home faster as your payments will be going towards paying off the principal.

A straight refinancing is the most opted for refinancing option. A straight refinance means that the borrower refinances the exact amount he needs to pay on an existing mortgage. The borrower does this to change the terms of the existing mortgage or to take advantage of lowered interest rates.

Cash out refinancing is another option to acquire extra cash to take care of current important expenditures. In this type of refinance, you can borrow against the equity of your home and borrow an amount more than your existing mortgage and use the extra cash to pay for say, some important expenditure like repairs on the house or college fees for the children. Since cash-out refinancing accesses the equity built up in your home some factors must be considered when opting for cash-out refinance:

    1) How much cash you require, when and for how long.
    2) Costs of associated fees.
    3) Short and long term effect of a refinanced loans rates and term period.
    4) Is the extra cash absolutely essential or can you trudge along without it.

Saving on the Private Mortgage Insurance (PMI):

When you purchased the house and were unable to make a down payment of 20% of the property's value, then you would have been required to buy Private Mortgage Insurance (PMI). In the subsequent years if you have diligently paid your monthly payments and your house has appreciated since then, your house equity may be more than 20%.

If you refinance now you will no longer required to pay PMI. When Tom and Danielle Condon refinanced, the prices in their area had increased, thereby increasing the equity of their home that resulted in a saving on PMI of $160, which earlier they had to pay.

The conditions for approval of a refinance are a mite different than for a purchase loan. Most lenders do not allow a 100% refinance of the property's value. The choice of a refinance loan is same as when you were purchasing a house. There are fixed-interest rate loans, adjustable interest rate loans and government loans.

Refinancing is not advantageous when:

    1) Interest rates have not significantly lower than when you purchased.
    2) The existing mortgage has covered a substantial term of its life.
    3) If you have repaid most or all of the interest on the existing mortgage.
    4) The existing mortgage contains a pre-payment penalty issue.

Refinancing example

Refinance of a single family owner occupied home worth about $ 700,000. The current mortgage on the loan is $559,000 that calculates to a loan to value rate as 79%. The borrower has good credit rating, a FICO score of 644. Current interest rate is 6.61% on a loan term of 30-years. The monthly amortization schedule is $300 a month.

On refinancing the borrower intends to take cash amount of $20,000. Mortgage closing costs is $5000. New interest rate is 6.11% on a 40-year loan. Hence new loan amount after refinancing is $584,000. Monthly amortization schedule is $2750 giving the borrower a saving of $250 a month from their earlier payment.