You have several years of on-time mortgage payments behind you and equity built up in your home. This might be a good time to take advantage of financing rates and renegotiate your mortgage for more favorable terms that will send your mortgage payment down. And that's always a good thing. You may also be able to reclaim some of the money you already paid on your home loan with a cash-out refinance. Although both types of mortgage renegotiation have their benefits, which one works best for you depends on what you want out of your refi.
Home Equity Basics
To understand the concept of refinancing, you must be clear on the basic concept of home equity. As logic dictates, the longer you make mortgage payments on your original loan, the less you owe on your mortgage. The difference between the market value of your home and the amount you still owe on your mortgage is known as equity. For example, you purchased your home for $200,000 and its value stayed constant. You still owe $140,000 on your mortgage, so you have $60,000 in equity. Roughly speaking, you own about a 30 percent “share” of your home, regardless of how many years are left on the mortgage.
If you have a considerable amount of equity in your home, you can reclaim its value through a cash-out refinance. In these refis, you take out a new mortgage for your home’s value, less a down payment, which often varies between 10 and 20 percent. In the example case, of a home valued at $200,000 with $140,000 left on the mortgage, you could put $30,000 down and finance the remaining $170,000 with a new mortgage. The new mortgage pays off the original mortgage's balance and any left over, a cool 30 grand in this case, goes into your pocket, and you can spend it however you choose. You’re back to square one on your house payments, however; with no equity but a down payment in the home, and you begin paying down the loan's full amount again. Although you can receive a large amount of capital in a cash-out refi, you’re also drastically increasing the amount of interest you pay over the life of both mortgages.
Traditional Refinance for Interest Rates
Even if you don’t need the mountains of cash that you could receive in a cash-out mortgage, you may still wish to refinance when interest rates fall just to reduce your payments and have a bit of extra cash at the end of the month. Because lenders incorporate interest payments into monthly payments, lowering your rate lowers your payment. Following the example, if you have a $140,000 balance left on your mortgage, you could refinance a 6.7 percent loan to a 4.8 percent mortgage on the remaining balance. If you pay this note off in 15 years, you'll save $46,165 in interest over the life of the loan. That lowers your monthly payments by a little more than $256 over the next 15 years.
Traditional Refinance for Time
Even if interest rates aren’t doing you any favors you may be able to shrink your mortgage payment by refinancing the remaining amount left on your loan. In the example, if you owe $140,000 on the mortgage of the home valued at $200,000 and are in the 11th year of a 30-year note, you can choose to refi to pay off the remaining balance. The $60,000 in equity remains in your home -- it acts like a down payment in many ways -- and you start over from square one on a brand-new 30-year mortgage for the unpaid $140,000. Because the refi is for thousands less than the original mortgage, your monthly payment will shrink considerably. The down side? Because it takes longer to pay off the loan, you’ll pay more in interest charges over the life of both loans -- 11 years’ worth in the example.
Wilhelm Schnotz has worked as a freelance writer since 1998, covering arts and entertainment, culture and financial stories for a variety of consumer publications. His work has appeared in dozens of print titles, including "TV Guide" and "The Dallas Observer." Schnotz holds a Bachelor of Arts in journalism from Colorado State University.