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

Okay.

You buy a house for £100,000. You get a 10% mortgage – you pay a £10,000 deposit, and mortgage the remaining £90,000. You decide to pay your mortgage back over 10 years, at £750 per month (Ignoring mortgage interest for the sake of simplicity. Note also that these figures are wildly out of step with reality for most house purchases).

A mortgage is simply a loan secured against a piece of property – almost always used to purchase the property in question.

Cut to 5 years later. You have paid 5*12=60 payments of £750 towards your mortgage, for a total of £45,000 repaid. Your remaining outstanding mortgaged amount is £45,000 (£90,000-£45,000=£45,000).

By paying a 10% deposit, then repaying 50% of the mortgaged amount, you now own 60% of the property completely free of finance. The remaining 40% is still mortgaged. This isn’t *literally* true, but it can be helpful to think of it that way.

Five years have passed since you bought the house. You get your house re-valued, because you’ve made some improvements to the house in that time, and the housing market has also changed.

Congrats, your house has increased in value! It’s now worth £130,000, £30,000 more than you bought it for!

You decide you want to re-mortgage (e.g., move your mortgage to a new financial provider) to try and get a cheaper interest rate.

You reach out a new mortgage supplier. You tell them (simplified):

**”I own 60% of this £130,000 house. I am looking to re-mortgage the remaining 40%, valued at £52,000.”**

You find a mortgage company who is willing to do business with you. They offer you a mortgage of £52,000 at a competitive interest rate. You accept it.

Remember, though… under the terms of your *original* mortgage, you only had £45,000 left to pay off. You’ve *gained* £7,000, because your house is more valuable than it was when you bought it.