Mortgage Refinance Guide
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Home Mortgage Refinance
what is it?

Home mortgage refinance - we will begin with a simple explanation of what it is.

When a home buyer takes out her first loan to buy her home, the loan is known as the first mortgage.  This loan is a secured loan because the home is pledged to the lender as security.  If the borrower defaults in her loan repayment, the lender has the right to sell the home to recover the debt from the sale proceeds.

When the borrower takes out a second home loan to replace the first mortgage, the second home loan is known as the second mortgage, obviously.  To replace the first mortgage, the borrower uses the second mortgage to pay off the first mortgage (ie the first lender), and pledges her home to the second lender as security.  This transaction is therefore known as a home mortgage refinance.

A home mortgage refinance may be undertaken to:

  • reduce interest costs (this is made possible when the second mortgage carries a lower interest rate than the first mortgage),

  • pay off other debts (this is made possible when the second mortgage is larger than the outstanding balance of the first mortgage, so that after paying off the first mortgage the borrower is left with some cash that she can use to pay off other debts.  This type of home mortgage refinance is commonly known as cash-out mortgage refinance).

  • reduce one's periodic payment obligations (this is usually achieved by taking a longer-term second mortgage.  For example, let's say the borrower still owes $50,000 under the first mortgage, and will fully settle the loan in 10 years if she makes her monthly repayment instalments without fail.  To lower her monthly repayment amount, she can take out a second mortgage of $50,000 that is to be fully settled in, say, 15 years.  By lengthening the repayment period from 10 years to 15 years, she reduces her monthly repayment instalment),

  • reduce risk (such as by replacing a variable-rate first mortgage with a fixed-rate second mortgage.  With a fixed-rate loan, the borrower has zero risk of having to pay more loan interest because her interest rate is fixed upfront by the loan agreement throughout the life of the loan.  By contrast, with a variable-rate loan, the interest rates rise or fall according to unpredictable market conditions and government policies, and thus the loan is more risky), and/or to

  • liquidate some or all of the equity that has accumulated in the borrower's home during the tenure of her ownership.  This usually involves home equity loans. Click here for a fuller discussion of home equity loans.

It is advisable to speak with a home mortgage refinance professional who is familiar with your existing mortgage loan, before deciding to refinance. Certain types of loans contain penalty clauses that are triggered by an early payment of the loan, either in its entirety or a specified portion. Also, some refinanced loans, while having lower initial payments, may result in larger total interest costs over the life of the loan, or expose the borrower to greater risks than the existing loan. Calculating the up-front, ongoing, and potentially variable costs of mortgage refinancing is an important part of the decision on whether or not to refinance.

Related article: Mortgage Refinance: when should you do it?

Click here to discover how to quickly build a minimum of $40,000 worth of home equity and pay your mortgage off in 10 years or less without making biweekly mortgage payments.

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