When you start looking for a home mortgage refinance loan, you will need to know which type you want. The type of home mortgage refinance loan you choose will depend on why you want to refinance your existing mortgage. The common reasons to refinance your mortgage are to save money, get extra cash or pay smaller monthly payments (Guttentag 74). If you want to save money or pay smaller monthly payments, a rate/term home mortgage refinance loan will probably work best for you. If you need some extra cash, you will need a cash-out home mortgage refinance loan.
Rate/Term Home Mortgage Refinance Loan
A rate/term home mortgage refinance loan is used to either change your interest rate, loan term or both (Milligan 214). When you get a rate/term home mortgage refinance loan, you trade a new mortgage for your old one. The only thing that will be different about your new mortgage is your interest rate or term length (Fabozzi 292). The amount you have to repay on your new mortgage will be the same as the outstanding balance on your old mortgage. For example, if your original mortgage was for $200,000 and you already paid off $50,000, then your outstanding debt on your original mortgage is $150,000. If you were to get a rate/term mortgage, you would borrow $150,000 to pay off your first mortgage and start making monthly payments on your new mortgage.
It may seem like a waste of time to trade one mortgage for another; however, if you can get a new mortgage with a lower interest rate or shorter term, you will save money. To understand why a lower interest rate will save you money, let's pretend you have the choice of a $200,000 15-year mortgage with either a 10% or 8% interest rate. If you choose the mortgage with the 10% interest rate, your monthly payment would be $2,149.21 and your total interest payment over the life of the mortgage will be $186,857.84 ("Mortgage Payment Calculator"). Whereas, if you choose the mortgage with the 8% interest rate, your monthly payment would be $1,911.30 and your total interest payment over the life of the mortgage will be $144,034.75 ("Mortgage Payment Calculator"). Choosing the mortgage with the 8% interest rate will save you $42,823.09, which is a big incentive to get a lower interest rate.
Getting a shorter loan term will also help you save money. Let's say you have the choice between a $200,000 mortgage with an 8% interest rate and a loan term of either 30 or 15 years. If you choose the 30-year mortgage, your total interest payment over the life of the loan would be $328,310.49; whereas, you would only have to pay $144,034.75 in total interest for the 15-year mortgage ("Mortgage Payment Calculator"). You would pay $184,275.74 more in interest for the 30-year loan. That's almost how much you borrowed.
As you can see to get the best deal, you want to get the lowest interest rate and the shortest term possible when you get a home mortgage refinance loan. Don't get discouraged by the higher monthly payments that come with the shorter-term mortgages. If you can afford the larger payments, make them. It will save you from paying your lender thousands of extra dollars in interest, and I'm sure you can find a way to better use that money. Cash-Out Home Mortgage Refinance Loan
If you are in the market for extra cash, whether it's to pay for credit card debt, home improvements or college tuition, then a cash-out home mortgage refinance loan may be right for you. When you get a cash-out home mortgage refinance loan, you borrow more money than is needed to repay your current mortgage. Which may leave you wondering where the extra cash comes from.
After living in your home for a couple months or a few years, you start building up equity in your home. Equity is the portion of your home that you own ("Glossary"). For example, let's say your home is worth $300,000 and you have only $200,000 left in principal to pay on your current mortgage. Therefore, you have $100,000 in home equity. If you need extra money, you can turn that equity into cash by getting a loan. If you were to take out a cash-out home mortgage refinance loan, you could possibly borrow $250,000 on your new mortgage. When you get the money, $200,000 would be used to pay off the balance on your old mortgage and you could use the $50,000 on whatever you wanted.
When it comes to how much you can borrow with a cash-out home mortgage refinance loan lenders normally will only let you borrow up to 90% of the value of your home (Reed 153). For example, if your home was worth $100,000, you could borrow $90,000. However, the amount you are allowed to borrow may vary depending on your credit rating and employment status. If you have a low credit rating or are self-employed, you probably won't be able to borrow 90% of your home's value (Sutton 33).
While it may seem like a great deal that you can get extra money from your new mortgage, not everything about a cash-out home mortgage refinance loan is good. Often the interest rate on a cash-out home mortgage refinance is higher than the interest-rate on your first mortgage (Guttentag 74).
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