What is Refinancing??

[Aaryan Patel]

What is the concept of refinancing? Why would someone want to do it? What are the differences in the different types such as cash out refinancing, HELOC, and Home Equity Loan. I have heard of all these, but the concept of refinancing hasn't "clicked" yet.

[Kerry Baird]

I buy a house with a mortgage and use a percentage of my own cash, say 80% mortgage and 20% cash.  

Over time, the house increases in value (due to inflation and/or demand) and the tenant pays down the mortgage balance.  The percentage of equity changes.  My houses might now have 50% mortgage and 50% equity.  So I go to a lender.  They pull my credit score, and charge a fee for an appraisal to determine what the market value is.  The lender agrees to lend me more money on the house; we pay off the old mortgage and borrow against the house again.  I now have refreshed the debt on the house.  

I can get a lower interest rate on the mortgage, and get no cash out.  The lower rates means I have a lower monthly payment. I could change the term, and refresh it to a 30 year mortgage, or I could shorten the number of years to pay off the mortgage more quickly.  This is how I understand a rate-and-term mortgage.  No cash out.

I could get more money out of the house with a larger mortgage than I had before.  Or I can get the same amount in a new mortgage as I started with.  This extra cash back to me makes it a cash out refinance, and that cash is not taxable; it is still debt that I am responsible to pay. I can get my original deposit back, and then tenants continue to pay down the mortgage over time…and in a few years I can do this again.  My return on investment goes to infinity if I pull all of my own cash (that initial deposit) back out.

A HELOC is most often a variable rate mortgage, often is "behind" a regular 30 year mortgage. In this scenario, I might have a really good rate and don't want to remortgage. But I want to use the equity that has built up. These loans can be drawn upon and paid back again over and over. They are often cheaper to set up, but require full documentation with credit pull, proof of income and bank statements. An appraisal is still needed and they can take quite a bit of time to put in place…not quick and easy. But flexible.

Home Equity Loan is also a smaller mortgage, behind a regular 30 year mortgage, and is most often a fixed interest rate.  I have seen them when I was younger when I did not have a large down payment.  We might have put 5% cash into the purchase, and got a 80% first mortgage and a 15% second mortgage.  The reason why to use them is to keep as much of my own money in my pocket.