What does refinancing a loan mean

By Matt Mayerle
Modified on May 8, 2023
what does refinancing a loan mean

Becoming a homeowner is a tremendous accomplishment, especially in this day and age where purchasing property is far more difficult than it used to be. But just because you are a homeowner does not mean that you no longer experience financial struggles. 

Going through a challenging time in your finances can be magnified when you own a home because it can become overwhelming trying to make your monthly mortgage payments. This is one of the main reasons why homeowners might choose to refinance their mortgage loan. Mortgage refinancing could allow you to access more affordable monthly payments or a more competitive interest rate. 

Before going forward with the refinancing process, it is important to have a clear understanding of how refinancing your mortgage works, including what the pros and cons are, so you can determine whether it is actually the right choice for you.

What Does It Mean To Refinance a Mortgage Loan?

The process of refinancing your mortgage entirely replaces your current loan with a new loan with new terms and a new interest rate. Obtaining a refinance loan could allow you to get a loan term that offers you more affordable payments or an interest rate that can help you save money.

You can refinance your mortgage loan with a brand new lender or simply re-apply with your current lender for updated terms, conditions, and interest rates. When refinancing your existing loan, you may also be able to obtain some extra money through a cash-out refinance. A cash-out refinance allows you to borrow additional cash through the equity you have already built up in your home. 

Through mortgage refinancing, you have the opportunity to lengthen your loan term to get lower monthly payments, shorten your loan term to pay off your balance off sooner, access a lower interest rate, alter your loan type, get a cash-in refinance, or a cash-out refinance.

Reasons To Get a Mortgage Refinance

There is a variety of reasons why homeowners might decide to refinance their mortgage loan. If you are considering refinancing, here are some of the reasons you might decide to go forward with refinancing:

Lower Monthly Payment and Interest Rate

If you are struggling to make ends meet, you might want to refinance your loan to access a lower monthly mortgage payment. Applying for a rate-and-term refinance loan could allow you to lengthen your current loan’s term, so your monthly payment gets reduced. Similarly, if you have improved your credit score or market rates have dropped, you might be able to access lower interest rates by refinancing a new loan. A lower interest rate could lessen the amount of money you need to pay in total for financing your house than you would have had to pay on your existing loan.

Change Your Rate Type

When financing a house, you can have either a fixed-rate mortgage or an adjustable-rate mortgage. If you are having regrets about which rate type you got when you first took out your loan, you can refinance your loan to switch from an adjustable rate to a fixed-rate mortgage or vice versa. Refinancing to a fixed-rate mortgage could help you avoid the impact of market fluctuations.

Adjust Your Loan Terms

Shortening or lengthening your loan terms can have its own benefits. Shortening your loan terms will allow you to pay off your home sooner than you’ve planned, saving money on interest in the process. Lengthening your loan terms will lower your monthly payment which, while not saving you money in the long run, could be necessary for managing your budget.

Obtain Some Extra Cash

If you have paid off a significant portion of your loan, there may be considerable equity in your house which means you might qualify for a cash-out refinance. You could take out the additional money and use it to finance a large purchase, consolidate debt, or any number of other things.

Pay Down Your Balance

Another more rare reason that homeowners might choose to refinance is to pay down the balance considerably. A cash-in refinance is typically considered if you are underwater on your mortgage, meaning you owe more than the house is worth, or if you wish to be rid of your private mortgage insurance.

Drawbacks of a Mortgage Refinance

Just like with every other big financial decision you make in your life, there are always drawbacks to consider. It is always good to consider both sides when attempting to make a smart decision. Here are a few of the possible cons of refinancing your existing loan:

  • If you lengthen your loan term, you may end up paying more in interest charges over the life of the loan. 
  • While in some circumstances refinancing your mortgage could result in lower monthly payments, that is not always the case. If you end up doing cash-out refinancing, you could end up having a larger monthly payment.
  • If you haven’t broken even on your closing costs yet, it might be a better idea to stick with your current loan.
  • Market conditions are unpredictable and cannot be controlled. Attempting to get a refinance loan while the market conditions are not ideal could mean you don’t get better terms than you started with.
  • Qualifying for a refinanced loan can be difficult depending on your credit score and financial situation. Applying for refinancing multiple times could result in too many hard inquiries on your credit report, which could bring your score down.
  • While you may be able to lower your monthly payments by refinancing a new loan, you will be stuck paying off your loan for longer than you had intended which could have long lasting consequences. 

How to Better Budget Your Mortgage Payments 

Planning and organizing a monthly budget can be difficult when you are experiencing some financial struggles. If you are having trouble affording your mortgage payments and you are not able to obtain a cash-out refinance, you might need to re-imagine your budget to live more frugally until things become more stable.

It is vital to make each monthly payment on time, as having a roof over your head and keeping your credit score in good shape are top priorities. Here are some recommendations that could help you budget your monthly expenses easier:

Take a Look at Your Current Budget

The first thing you will need to do is sit down with what your current budget looks like and analyze where most of your money is going. If you don’t have a set budget you follow, print out a couple of bank statements and look at those. 

As a homeowner, your budget should revolve primarily around your mortgage payment, as it is likely your largest expense. Food and housing are your most basic needs and are therefore central to your budget, as they can’t be sacrificed for other expenses. What percentage does each category of expense account for in your monthly budget? 

Review Your Necessities vs. Wants

Once you’ve figured out the proportions of your current budget, divide up what expenses qualify as necessities and which qualify as wants. It can be challenging at times to determine the difference between needs and wants when it comes to money. But it is incredibly helpful to pinpoint exactly what you spend every month on food, shelter, healthcare, and utilities. Pretty much everything else can be classified as a want.

While it is not realistic to live on a budget that is exclusively necessities with no room for wants, there are ways to minimize the wants in your budget in a sustainable way. It is possible to live comfortably while still being frugal so that you can get back on your feet. You can slowly re-introduce the little luxuries of life as you become more financially stable.

Re-arrange the Proportions of Your Budget

Minimizing the portion of your income you have typically spent on wants will automatically increase the money you have to put toward your needs. This should make your monthly mortgage payments more affordable on your income as it stands. Some simple finagling of your unnecessary expenses could make your housing costs suddenly affordable. 

Consider canceling some streaming services or other subscriptions. Take a few months off going out to eat or ordering delivery for dinner. Start packing your lunch and make your coffee at home. Each minor cost you cut will increase what you have to put towards your monthly payment.

Reduce Your Other Debts

How much money are you spending every month on your other debt payments? It can be incredibly challenging to afford your bills when you are needing to pay a ton of monthly payments on high-interest debt like credit card minimums or quick cash loans. Minimizing your other debts, especially the high-interest ones with a monthly payment, will free up a significant amount of money, making it easier for you to afford your mortgage. 

How Does Refinancing a Mortgage Work? | Experian
What Does It Mean To Refinance A House? | Quicken Loans

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