How Does Home Refinancing Work?

Mortgage Introduction

A mortgage is a collateralized loan traditionally backed by real estate. Over a period of time, the mortgage balance is paid down to zero by paying both the accrued interest and an amount of principal with each payment.

Pay Off Original Mortgage

In order to refinance a mortgage, the first mortgage must be paid off. During the application and approval process, an estimate of the mortgage balance is used. Upon completion of the paperwork, the financial institution that is handling the refinancing will request a payoff amount from the original mortgage holder. This is necessary, because a mortgage accrues interest every day, so the amount required to pay it off is higher just one day later. The original mortgage holder will respond with a payoff amount and date. The financial institution doing the refinancing will then send a payment electronically or via overnight mail to pay off the original mortgage.

New Mortgage

During the refinancing process, the lender doing the refinancing will originate a new mortgage for the borrower. The new mortgage will have new terms that have been agreed upon prior to payment being sent to the original mortgage holder. These terms include resetting the payment schedule to the new term of the loan. For example, a borrower may refinance a mortgage with a new 30-year mortgage and the new payment will reflect the amount necessary to pay off the mortgage in 30 years, regardless of how much time was left on the original mortgage. The new mortgage is originated on the same day as the original mortgage is paid off, so there is no "float" for either the borrower or the lender. The refinancing is then complete.