Am I the only one who doesn’t understand how mortgage refinancing works? I’m having trouble understanding how a loan instrument can be used to purchase more properties or even negotiate better rates.

Question

How are these advantages possible AFTER a mortgage has been signed? Help needed as I’m trying to wrap my head around financial mechanisms – why is this a thing and under what circumstances/ conditions does a refinancing make the most sense to use?

In: 293

Answer 1

There are a few different things going on. The main factors are that over time the amount of money I owe on the house decreases as I pay the loan down, and the amount the house is worth is worth more as it appreciates. If things don’t go that way then it often doesn’t work.

The house is basically my collateral on the loan.

I borrow money and buy a house. Later I refinance by finding someone else who will loan me money using the house as collateral, and I borrow money and then pay off the first loan. That is a refinance. This works well if the second lender is willing to give me a lower interest rate than the first lender. This is often because conditions in the credit markets have changed, and the overall interest rate environment is lower.

Or if my house has gone up a lot in value, and I decide that I want “extra” money at my disposal for a project, vacation, a new toy, a kid’s wedding (for real), or (bad idea) to buy bitcoin with, for a home improvement project, or to invest in new property, I go to the bank and tell them that since my house is now worth more, I would like to use it as collateral on a new and larger loan, or on an additional loan. This can be a good idea since a mortgage loan is going to have a lower interest rate than something like a credit card.

My debt and my mortgage payment have increased. However, it gives me money NOW which I can use. Some people take this and put a bunch of money down on an investment property and rent it out and make some money and built more “equity” (the amount of money the property is worth more than what you owe on it), some people will blow the money buying things they don’t need to impress people they don’t like.

For many homeowners the goal is never to actually pay off the house, but to keep a manageable payment to fund a lifestyle. The banks are laughing all the way to the bank. (wait, what?)