I don't understand Refinancing

[Account Closed]

Hi Guys, 

Sometimes its the simplest concepts that I overthink, but I am having a bit of trouble comprehending a refinance. Lets assume I take out a mortgage for X amount amortized over 30 years at 6%. When I refinance, does the balance stay the same (effectively making me start the payment process all over again)? Or do I only apply for the amount that I owe since I will have built some equity in the property. Also, I don't understand how a new down payment would be needed when refinancing. Am I meant to to bring 20-30% of the appraised value?

Simple concept that I am almost sure I am over-analyzing, but I would appreciate your guys' help.

Thanks. 

[Kevin Siedlecki]

@Account Closed. I think you are overthinking it, but that's because you are trying to hold 3 different scenarios in your head at once, and trying to make them all make sense together. Below is my effort to separate those scenarios and make them more concrete for you. Hope it helps!

Scenario 1: You have been paying a mortgage for a while, and want to refinance for a lower monthly payment. The balance on your loan is lower than it was when you first bought the property, so you refinance for the balance of the current loan. Since the balance is lower, even if the rate is the same, you will pay less if you use the same amortization as the original loan.

Ex: Bought a house for 100,000. Original loan: 80k for 30 years. You paid the loan for several years, and now the balance is 60k. You refinance for new 30-year loan. Since you're borrowing 60k instead of 80k, the payments are lower.

Scenario 2: You have significant equity in the property that you want to take out in a cash-out refinance. You can borrow up to 80% LTV, regardless of your purchase price. The new loan pays off the old loan, and what's left, you get to keep. Barring a huge drop in interest rate, this will result in a higher payment.

Example: That same $100,000 house appreciated to $150,000 while you were paying the 80k mortgage down. Your balance is 60k again. 80%LTV allows you to borrow $120,000. So you borrow that at a 30 year amortization, use 60k to pay off the loan, and the rest (after closing costs) you put in your pocket (tax free, by the way).

Scenario 3: You would only have to bring money to the table if your house has fallen in value, and you no longer own 20% of it. The only reason you would do this is rates have fallen or you've been paying the loan down for a while, and need a lower monthly payment. This actually happened to a friend of mine, and probably a lot of people who bought in the mid-2000s. The reason to bring money to the table is that you will make up for that initial payment in just a few years of the lower payments.

Example: That same $100,000 house is only worth $70,000 after a downturn in the neighborhood. You've been paying your mortgage down, so the balance is 60k. But you have only 10k in equity, which is less than the 20% the bank requires. In order to satisfy the LTV requirement, you need $14k in equity. So you bring $4k to the table, technically making an extra payment on your old loan, to bring your ownership to 20%. But, since rates are so good, and you are paying on a loan of $56k ($60k balance - $4k cash at close) instead of $80k, your payment is significantly lower.