Mortgage refinancing is the origination of a new loan on a piece of property that already has a mortgage in place. When a property is refinanced, the current loan is paid off and a new loan agreement is drafted between the original borrower and the new lender. Most people decide to refinance their mortgage in order to either reduce their interest rate or loan term, or to access the equity they've built in the property. A lower interest rate can reduce a borrower's monthly payment, a shorter term can reduce what's paid out in interest, and accessing equity can provide access to cash when it's needed.
When a mortgage is refinanced in order to access equity, that is called a "cash out refinance". Equity is defined as the difference between what's owed on a property and what it's worth. For instance, if a borrower owes $100,000 on a $150,000 property, they have equity of $50,000. If they wish, they can refinance, get a new loan, and as part of that loan's terms, they can cash out part or all of their equity.
When refinancing for better rates and terms, the borrower should determine what they will save each month with the new loan. Then, they should look at the entire cost of the loan- fees can include origination fees, points/prepaid interest, appraisal fees, credit check fees, title, tax and escrow charges. When a borrower has all that information, they can determine how long they will need to retain the property in order to pay for the cost of the new loan.
With cash out refinancing, a borrower needs to remember that taking their equity out will result in a loan that's larger than their current mortgage, which usually results in a higher monthly payment. Careful consideration should be given to whether the intended purpose of the loan is worth the increase in monthly payment and total amount of the loan. Most finance experts believe that home equity should be used to improve the home in ways that will increase property values.