What really happens when you refinance?

Question

I'm curious if someone can explain this so I can understand how refinance works.  If I were to finance a house for $100,000 then later refinance for $150,000. How is it that you make $50,000? Would that not just be an extra $50,000 into the loan making the monthly payments higher? Or is this something that would only work if cash were paid for the house? And if that's the case wouldn't that lead to having a loan on the house and having to pay monthly payments? Any information explaining this would be greatly appreciated.  Thanks all!

Chris Mason · Answer

You aren't really "making" $50k. You have $50k more in your pocket, and you're $50k more in debt. Your net worth is exactly unchanged, you've just liquidated a portion of it.

Shon Drennan · Answer

@Kelly N. Thank you so much that was incredibly helpful

Kelly N. · Answer

You can refinance for several reasons:

1. To get a better rate, or change the term of the loan- for instance, changing from a 30 year fixed to a 15 year fixed rate loan.

2. To change the type of loan- say you have a loan with an adjustable rate, or a construction loan you now want to roll into a conventional loan.

3. To pull cash out, which is what most people will be talking about when investing in real estate.  So you buy a property for $100k, pay the mortgage for a couple of years and now it's worth $200k.  It was an investment property, so you had put $25k down, and still owe about $70k.  You can take out a new loan for up to 75% of the new value- $150k.  You repay the balance on the first loan and now have $80k to use towards whatever you want- another purchase, rehab costs, etc.  But, you also have  loan payment on that $150k, the rate may have increased, and if you stay with a 30 year fixed rate loan you are now making payments longer since you are restarting that 30 year clock.

We are currently doing #3 to get some cash for the rehab of a house we are paying cash for, then we will go on to #4

4.  Pay cash for a house, and THEN get financing on it, and use that money towards the next investment (or whatever).   We're using this on a house that currently won't qualify for financing, we will fix it up and rent it out, then finance it.  We could also get a rehab loan for the property based on what it is projected to be worth, but for us this seems to be the way to go.

Keep in mind, for rental property (2-4 units) the banks are going to require 70-75% loan to value, meaning that the maximum you can finance for will be 70-75% (depending on the situation) of the current value of the house.  I think you can get 5% more out of a single family rental, I am not sure.

You can also refi your own home, and use that cash for something else, but personally I would rather move towards paying off our home rather than taking on more liability there.