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When a borrower refinances his mortgage, he is replacing the current mortgage debt with a new loan. This is done either to reduce his interest expense or to cash out equity in the home for other uses.
Significance
The length of the average mortgage is 30 years, which is a long time to hold the same debt. Borrowers' needs and budgets change, sometimes necessitating a new mortgage structure. Refinancing accomplishes just that.
Function
A borrower can refinance to reduce the interest rate and payment, cash out the equity, or to change the borrowers on the loan in the event of a divorce or death.
Types
A refinance can be to a fixed or variable interest rate note, with terms ranging from 10 to 40 years.
Considerations
It is usually financially beneficial to refinance a mortgage if the new interest rate is more than 1 percent lower than the current rate and the borrower breaks even on the closing costs within 2 years of the refinance.
Warning
Refinancing is expensive and should not be done often. It can cost between 3 and 6 percent of the loan amount, according to the Federal Reserve.
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