Refinanced Mortgage

What is a Refinanced Mortgage?

Refinancing a mortgage means replacing your existing mortgage with a new one, usually to get better terms like a lower interest rate or lower monthly payments.

Imagine you want to buy a new house. Maybe you’re trying to move, need space, or just want a new scene. Either way, you’re going to need to buy a house. But houses are expensive. The average cost of a house in the U.S. is $350,000. (As of 2022)

But the median wage of a U.S. citizen is only $70,000. It would take nearly 5 years to buy a house! Not to mention living expenses and taxes! What are you going to do?

Well, you could take out a loan! Loans specified for houses are called mortgages. These mortgages are often taken out through banks or even credit unions. 

Because of the large capital required for real estate, mortgages are heavily regulated. It is not as easy to obtain a mortgage as it is to get a personal loan. Banks require proof of financial security, a stable income, and a good credit/credit score history. 

Additionally, the property bought with the mortgage will often be used as collateral to secure the loan. This added level of protection gives the homeowner. 

This will often only allow a select number of borrowers to obtain mortgages on their loans. This also will leave some borrowers unable to obtain mortgages. A solution to this problem is to refinance their current mortgages. 

How Do Mortgages Work?

Mortgages are loans taken out of the bank to purchase a house. Like most loans, they are paid back over time with monthly payments. 

Banks often require a downpayment because of the large risk of mortgages. A downpayment is an up-front payment of an expensive asset. For example, if you are buying a house, a downpayment of 20% is generally considered a good downpayment. 

This payment minimizes the bank's loan amount and shows the bank that you can save money and make good financial decisions. 

On top of paying monthly payments and putting down a downpayment, a borrower needs to pay off their loans with interest. Interest is the cost of borrowing money. 

Other factors include credit score, downpayment, financial history, and overall economic conditions. A small change in interest, even 1%, can drastically change the overall amount you pay. 

Understanding the Refinancing

Refinancing is like changing loans. Often, a homeowner will take out a different loan to pay back their current loan. The newer loan often has more favorable terms or an easier payment schedule. 

Refinancing begins after approaching a new or existing bank to take out a new loan. The new loan will have its terms re-determined based on current credit scores and other factors. The new loan will be used to pay off the existing loan and take its place.

This loan change can offer a homeowner a chance to take out a loan with better terms or conditions. Refinancing can also allow a person to lower their monthly payments and, therefore, lower a monthly financial burden. 

Although this action seems like an obvious choice that all homeowners should make to lower their monthly expenses, this can often lead to a dent in your credit score. Unfortunately, there are multiple cons to refinancing. 

But if used correctly, a change in loans can add extra free cash into your pockets. This extra cash can be spent on a multitude of things, but most often, it is used to pay off existing separate loans. 

Uses Of Refinanced Mortgage

When a homeowner's credit score goes up, a good option to consider is to refinance. A better credit score can mean the new loan will have better terms or be easier to access. 

1. New Interest Rate

A new interest can come from refinancing. You will certainly get a better interest rate by combining your new credit score and your old mortgage's history of on-time payments.

It's beneficial to check the interest rates of large and local bank chains in your area. Sources like Bank Rates can give you a fair estimate of what is available around you. 

Your payments show the bank that your ability to pay off a loan has increased. This will insensitive the bank to give you a loan and give you a better interest rate. 

2. Better Bank 

Sometimes, some banks are better than others. It is possible that another bank will offer a better deal for homeowners. 

3. Lower Monthly Payments 

With a new loan come new terms. If you refinance, your interest rate will probably be lower, the loan length will be cut, and overall payments will decrease. This all combines into a significantly smaller monthly payment. 

4. Free Cash

When getting lower payments, homeowners will have access to possibly hundreds of extra dollars per month. In most instances, this money is saved by the homeowner, but sometimes the money is used instantly.

This extra cash can be used to finance a renovation of the home. Renovations are expensive, but refinancing can finance the decision without taking out extra cash that you don’t have. 

5. Consolidating Debt

By refinancing, you can consolidate multiple debts into a single loan. This option is fantastic for homeowners that have multiple credit cards or smaller high-interest loans. 

By consolidating debt, you could maintain or obtain a lower interest rate when combining all your debt. Even a small decrease in interest could save hundreds of dollars monthly from high-interest loans. 

Pros And Cons Of Refinanced Mortgage

Not all situations or people will benefit from refinancing their mortgage. Some multiple pros and cons need to be considered before refinancing your mortgage. Refinancing is a big decision that can impact your monthly cost and financial future. 

Below are the pros and cons of mortgages. You must consider all of these factors and what they mean for you and your financial needs.

The pros are:

1. Lower monthly cost: Lowering your monthly cost is one of the main benefits of refinancing. A lower monthly cost can alleviate some burden and free some money for the homeowner. 
2.  Better terms: It can be in the form of a short or longer loan term. This can affect the loan's value and other factors of the loan. 
3. Better interest rate: A better interest rate can drastically change how much a homeowner will pay the bank. Fixing an interest rate is also a fantastic decision. If interest rates rise in the coming years, a fixed interest rate can save tremendous money.

The cons are:

1. Worse credit score: Although a mortgage is a fantastic way to skyrocket your credit score over the year, refinancing can actually hurt your credit score. When applying for a loan, banks will check your credit score. This is called a hard inquiry. When banks check your history and statements, it will cause your credit score to decrease temporarily. Although, if you continue to pay off your new loan, your credit score will go back up again.
2. Possible term reset: Your new loan can reset to the term of your original loan. If this occurs, you could have more monthly payments. This causes interest to have a larger effect on your overall payment and may outweigh the original value of refinancing. 
3. Reduced equity: Unfortunately, if you wish to sell your house in the future, you might not want to refinance. Refinancing can drop the value of your house or real estate. Your equity is based on how much you've paid on your monthly due. 

Regardless of the pros and cons of refinancing, profit is the number one factor that should be accounted for. The core idea of refinancing is to exchange your current mortgage for a newer and better mortgage. This often will lead to excess cash in the homeowner's pockets. 

Calculating Refinanced Mortgage

Calculating the break-even point is a fantastic way to calculate if a mortgage change is profitable. 

Closing costs of a mortgage are often disregarded when refinancing a mortgage. These costs include origination, application, appraisal fees, etc. These costs can add up to a price point in the thousands. 

This upfront cost can hinder a homeowner's ability to refinance or take a sizable amount out of a homeowner's savings. It's important that a new mortgage breaks even quickly in order to make the investment worthwhile. 

Calculating the cost is simple. You need to:

1. Subtract the monthly cost of your quoted mortgage from the monthly cost of your current mortgage. (This is the money you save per month by refinancing) 
2. Add all your closing costs (This is the total closing cost) 
3. Divide your total closing cost by the amount saved per month. 

This will give you the number of months it will take to make back or “break-even” the closing costs. 

This time period could be months or years. Generally, you want this period to be as short as possible. The shorter the period, the quicker you can start collecting the excess cash from refinancing. 

It’s important to consider your break-even point. If you plan to stay in your house for decades, a break-even point of years shouldn’t be a problem. But if you're hoping to remodel your house after changing mortgages, you’d want to find a new mortgage with a short break-even point. 

Types Of Mortgage Refinancing

Regardless of the overall pros and cons of refinancing, there are multiple types of refinances that you can apply for. Each has its special differences and advantages. It's important to go over all of them with your bank to see which one fits you the best.

Cash Out Refinance

The most basic type of mortgage is cash-out refinance. This type of refinance involves you taking out a new loan to pay off the existing mortgage. The new loan will take the place of the previous mortgage, and you will resume payments.

Generally, the second loan is larger than the first loan, and the difference between your first and second mortgage will often be paid to you in cash. If your financial history and credit score have improved, your second mortgage will have better terms.

This can equate to lower monthly payments, lower better term lengths, etc. 

Rate and Term Refinance 

Instead of taking out a new loan and using that to pay off your existing mortgage, a rate and term refinance is simply going to your bank and negotiating better terms. When interest rates drop, it may be beneficial to try and obtain better terms.

Usually, if your credit score or good faith in the bank improves, You can often negotiate your way to better terms on your mortgage. This can drastically lower your monthly cost, and you're expected to pay off your loan. 

Short Refinance

A short refinance is your last option. These are reserved for people who have unfortunately foreclosed on their mortgage and are at risk of having their home repossessed. Although the situation is unfavorable, this type of refinance can save both the homeowner and the bank.

Government Loans 

There are hundreds of loans available from the federal government. These loans often have better terms and are much more forgiving than private loans from banks. Departments like the USDA, the VA, the FHA, and other administrations from the federal government offer loans.

If eligible, taking out these loans is in your best interest. Not only are these loans backed by the US government, but they often come with benefits beyond a lower interest rate or monthly payments.

It's important to reference and look over these loans before going to private loans.

Applying For Refinance

Once considering the pros and cons of refinancing your mortgage, the option of refinancing is open. Although simply replacing a loan for another loan seems simple, it's a lengthy process that may cost you a lot of money in fees.

It's the bank's obligation to review all financial history documents and personal files. They must make sure that you can pay off a loan on time with interest. They also need to make sure that you can make an informed and healthy financial decision.

When you apply for a mortgage, any lender or bank will look into your income, job, assets, outstanding debt, credit score, financial history, etc. 

These documents give your lender a rough idea of how stable your financial life is. They will look at how much you make, how much you spend a month, and how much you have saved up. This tells them if they have the financial security to take on a new mortgage.

In addition to personal finance, A lender will require your spouse's document if you're married. It doesn't hurt to add a spouse's document as it shows a bank that another person can pay off a mortgage with you.

Applying To Multiple Banks 

It's also important to note whether you refinance with the same bank or with a different bank. Although refinancing with the same bank does have its pros, like a quicker time, there are a lot of benefits that come with refinancing with a difference.

Even though the same bank may still have your documents and make your application go through quicker, a different bank will often offer you better terms to secure a loan with you.

Some people may believe switching banks can cause you to lose good favor with your current bank, and although that may be true, it's still important to regard the benefits that come from working with a different bank. 

Homeowners looking to refinance should always shop around and get quotes from different banks. The benefits you can receive from getting different quotes far outweigh the benefits of sticking with a bank.

Some banks may offer a better interest rate, and some can give you a shorter term length. By applying or getting quotes from multiple banks, you gain access to different mortgages with different terms, rates, and conditions. 

With all these options, you can pick the best quote for yourself! Each homeowner's situation is different. Some owners want lower payments to remodel their houses, while others want their mortgages paid off faster. 

By allowing yourself to apply at multiple banks, you give yourself the best chance at securing a better mortgage and a mortgage tailor-made to your wants and needs. 

Research and Written by William Hernandez-Han | LinkedIn

Reviewed and edited by Naveeth Rishwan Habeeb | LinkedIn

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