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Refinancing: 3 Common Types of Refinanced Mortgages
by Amy Lillard
Whether you are looking to lower your monthly payments and interest, draw on equity in your home, or build equity faster, refinancing your mortgage may give the flexibility and extra cash you’re looking for. (Equity is what your home is worth minus the amount you still owe on your mortgage. If your home is currently worth $200,000, and you still owe $80,000 on your loan, your equity is $120,000. )
Refinancing usually involves obtaining a new first loan, issued on more favorable terms. This new first loan covers the remaining balance of your mortgage. Ideally, refinancing allows you and your family breathing room with monthly bills, or even provides extra cash for necessary expenses.
Refinancing can become complicated and costly, but knowing your reasons for refinancing, as well as the options available to you, can result in big benefits. The type of mortgage you select should depend on how long you expect to say in your current home, as well as budget.
Alternatively, if you procured your first mortgage as a 30-year fixed-rate mortgage, refinancing to a shorter term can mean reduced interest and increased equity. For example, if you have 25 years left in your fixed-rate mortgage term, refinancing to a 15- or 20-year mortgage can increase your monthly payments, but reduce the amount of interest you will pay over the term. This means more principal being paid off, increasing your home equity quickly.
Refinancing to fixed-rate mortgages is an especially helpful move for homeowners who intend on staying in their homes for several years or indefinitely.
Refinancing to ARMs may be a good option for homeowners stuck with a high interest rate in their fixed-rate mortgage. Additionally, borrowers who opted for an ARM with their original home purchase may decide to refinance to a different type of ARM to get a lower rate.
ARMs must be considered very carefully, as rates can vary widely from lender to lender, and from month to month. If you expect to spend more than just a few years in your home, refinancing to fixed-rate mortgages may be the better option to save money and build equity.
Cash-out refinances involve getting a new, larger mortgage to pay off the existing balance and provide extra cash. You can use this extra money to consolidate and pay off debt, pay for education, finance home improvements, or for other options. In our example above, the homeowner might be able to obtain a new $180,000 mortgage. The existing balance can be paid off, and the homeowner has access to an additional $100,000.
Typical cash-out refinances are limited to 90 percent of the total value of the home. You may find lenders offering more, but most will carry much higher risk and fees. Even with the usual cash-out refinancing options, borrowers must carefully consider the potential risks. By borrowing against your home, you may incur extra tax consequences. More dangerously, you risk losing your home if your ability to pay the additional monthly mortgage amount is compromised. Finally, many borrowers may increase their debt with poor spending habits.
Learn more about refinancing with our continuing article series, including the potential reasons to refinance, the process and costs, and common mistakes and ideal timing.
Related Article: Refinancing: Five Reasons to Rework your Mortgage
Related Article: Refinancing: Know the Process, and the Closing Costs
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