What is Mortgage Refinancing?

Definition of Mortgage Refinancing 

Mortgage refinancing is the process of replacing your mortgage or mortgages on your property with a new mortgage, generally with different terms than the original mortgage.

Some confuse mortgage refinancing with a second mortgage, but they are not the same. A second mortgage is in addition to your first mortgage, and does not replace it. Mortgage refinancing will provide new money to the borrower, and used to pay off the original mortgage, usually with better mortgage terms.

Example 1

Mr. McGillicuddy has a mortgage for $200,000 with Bank A at an interest rate of 7%. Mr. McGillicuddy discovers he can obtain a mortgage for $200,000 with Bank B at an interest rate of 5%. He then takes out a loan with Bank B for $200,000 at 5% interest, Bank B will use to $200,000 to pay off Bank A. Mr. McGillicuddy is under no further obligation to Bank A, since they have been paid in full, and he will now pay Bank B.

Sometimes, mortgage refinancing can be used to not only pay off the original mortgage, but to pay off other debts as well, provided the homeowner has sufficient equity in the real estate. In these instances, mortgage refinancing can become a form of debt consolidation.

Example 2

Mr. McGillicuddy has a mortgage for $200,000 with Bank A at an interest rate of 7%, but in addition, has $20,000 of credit card bills. Mr. McGillicuddy discovers he can obtain a mortgage for $220,000 with Bank B at an interest rate of 5%. So he takes out a loan with Bank B for $220,000 at 5% interest, Bank B will use to $200,000 to pay off Bank A and use the remaining $20,000 to pay off the credit card companies. Mr. McGillicuddy is under no further obligation to Bank A or the credit card companies, since they have been paid in full, and he will now pay Bank B.

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Advantages of Mortgage Refinancing 

If the interest rate on the new loan is significantly less than the original mortgage, the homeowner can save significant money, and have a lower monthly payment.

Using the second example, the original mortgage will have an approximate monthly payment of $1,317.21. When you add in the approximate monthly payment of $600.00 for the $20,000 in credit card debt, the homeowner has $1,917.21 to pay monthly.

If the homeowner can borrow $220,000.00 at 5% interest to pay off both the original mortgage and the credit card, the monthly repayment will be $1,174.12. The homeowner is now combining two debts and paying less than he did on the original mortgage. If the interest rate is significantly less, the homeowner may see a great deal of savings.

Disadvantages of Mortgage Refinancing

Because the lender is taking a security interest in real estate, many of the same closing costs associated with the original mortgage may be present. Costs such as title insurance, recording fees, attorney fees, appraisal fees and other closing costs may have to be paid again. The lending institution may be willing to waive some of these fees, especially if the original mortgage was recent. However, in many cases, the interest savings over time will more than make up for the payment of additional closing costs.

It is best to determine what closing costs and other fees might be associated with refinancing. At First Foundation, we will be happy to discuss the advantages and disadvantages of mortgage refinancing in order to determine if it is a good choice for you.

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Last updated Apr 10, 2014