Refinancing a mortgage means you get a new loan to replace the old home loan. There are numerous reasons to refinance a mortgage:
- To get a lower interest rate. This usually means a lower monthly payment.
- To get a shorter term, so the mortgage will be paid off sooner. Example: replacing a 30-year mortgage with a 15-year loan.
- To get a lower interest rate and a shorter term.
- To switch from an adjustable-rate mortgage to a fixed-rate loan, or vice versa.
- To extract cash from the home’s equity. This is known as a cash-out refinance.
Rate-and-term refinancing pays off one loan with the proceeds from the new loan, using the same property as collateral. This type of loan allows you to take advantage of lower interest rates or shorten the term of your mortgage to build equity faster.
Search for low rates on a mortgage refinance.
Rate-and-term refinancing refers to myriad strategies, including switching from an adjustable-rate mortgage to a fixed, or the other way around. For example, if you have an ARM that is set to adjust upward in a few months, you can refinance into a fixed-rate mortgage. Or if you have a fixed-rate loan and you know you’ll move in two or three years, you could refinance into a lower-rate 3/1 hybrid ARM.
Example of a rate-and-term refi
Devyn gets a $100,000 mortgage with an interest rate of 5.5 percent. Three years later:
- Interest rates have fallen, and Devyn can refinance with an interest rate of 4 percent.
- After 36 timely payments, Devyn owes about $95,700.
In this situation, Devyn can save more than $100 a month by refinancing and starting over with a 30-year loan. Or Devyn can save less every month, while paying off the loan in 27 years — in other words, keeping the original loan’s payoff date.
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Cash-out refinancing leaves you with cash above the amount needed to pay off your existing mortgage, closing costs, points and any mortgage liens. You may use the cash for any purpose.
To be eligible for cash-out refinancing, you must have sufficient equity.
Market value – All mortgage debt = Equity
Kris and Avery bought a house four years ago. Today, it’s worth $200,000 and they owe $120,000 on the mortgage. Their equity is:
$200,000 market value
– $120,000 mortgage debt
= $80,000 equity
Example of a cash-out refi
In the above scenario, Kris and Avery owe $120,000 on the mortgage and have $80,000 in equity. With a cash-out refinance, they could refinance for more than the $120,000 they owe. For example, they could refinance for $150,000. With that, they would pay off the $120,000 on the current loan and have $30,000 cash to pay for home improvements or other expenses. That would leave $50,000 in equity.
Before you refi, make sure your credit is mortgage-ready. Get your free credit score and report from myBankrate.