How Mortgage Refinancing Works
During the go-go days of the real estate bubble and the lending era before the banking crisis of 2008, understanding how refinancing a mortgage works wasn't necessary. After all, it seemed that anyone, anywhere, regardless of credit score or income could get a mortgage somewhere.
These days, things are different, and the first step to a successful refinance is understanding what refinancing is and how the overall mortgage process works.
While it sounds simple, the technicalities of banking, loans, and real estate actually make the process of refinancing very complex. Fortunately, the customer is usually not required to handle any of these details which are instead generally taken care of by either the lender or a title company.
There are two phases to refinancing a mortgage, getting the new loan, and paying off the old loan.
To understand how to refinance a mortgage, you first have to understand a little bit about mortgages in general.
A mortgage, of course, is a long-term (usually) loan for which real estate is used as collateral. Collateral is real property that is used to ensure the repayment of a loan. Should the borrower not repay the loan, the lender is entitled to take the property used as collateral from the borrower. In the case of real estate, the processes of taking the collateral is called foreclosure.
The terms of the loan are set out at the beginning of the mortgage and typically cannot be modified by either the lender or the borrower for the life of the loan. However, the loan may be sold by the lender to another financial institution, in which case, the mortgage continues as before, except that the payments would be sent to someone new.
In order to refinance a mortgage, there must already be an existing mortgage on the property. Refinancing is the process of terminating the original mortgage, along with any home equity loan or HELOC, and replacing it with a different mortgage.
Mortgage Refinancing Process
Getting a new mortgage via refinancing is similar in nature to getting the first mortgage on the property. The borrower, applies to a lender who makes a determination about whether to lend to the customer and under what terms, based upon several factors including the borrower's credit rating and the amount of equity in the home. Once the loan has been approved, the process moves to eliminating the current mortgage.
Since the original mortgage already has a claim to the property as collateral, the new loan cannot use the same real estate as collateral while that first mortgage exists. Most people do not have the cash on hand to pay off their mortgage out of pocket. Thus, they use the money from the new mortgage to pay off the original mortgage.
However, since the new lender will only make the new mortgage loan if they can use the property for collateral, and they cannot use the property until the first mortgage is paid off, there could be an impasse. The process of refinancing avoids this conundrum.
To refinance, the new lender (or the title company or closing agent designated by the lender) contacts the original lender and obtains a payoff value for a specific date. The proceeds of the new refinanced loan are sent directly to the original lender to pay off the loan, most often via a check sent overnight mail to arrive on the designated date.
This occurs after the borrower signs all of the documents to establish the new mortgage. If the amount of the loan is for greater than the payoff value of the original mortgage, any excess funds are delivered to the borrower, a process known as a cash-out refinance.
Now, the home owner has a new freshly refinanced mortgage, the old mortgage has been paid off, and the new mortgage has been put in place.
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