A refinance loan (aka “refi”) pays off an existing loan using the same property as collateral. There are two major reasons why people refinance: One is to change the rate and/or term and the other is access the equity in a home.
Rate and Term Refinance
A rate and term refinance loan is generally the same size as the loan it replaces. These types of loans are designed to either lower your interest rate or adjust your loan term (between different fixed-rate mortgages or between a fixed and an adjustable-rate mortgage). In order to decide whether a rate reduction refinance is worthwhile, the interest savings must be weighed against the fees associated with refinancing. For instance, if the loan will cost you $2,000 and you are saving $200/month, then you are looking at 10 months to recoup your expenses. As long as you plan to live in the house longer than 10 months, it would be a worthwhile investment.
A cash-out refinance (“cash out refi”) is a mortgage which replaces your current loan with a larger one allowing you to pull equity from your house as cash. This cash can be used for any purpose, but is typically for home improvements or to consolidate debt.
No Cost/No Fee
A no cost refinance is a loan that has no out-of-pocket cost. These types of loans often make it a no-brainer to apply for a rate and term refinance because there is nothing to lose. Then, if rates drop again six months later, you may be able to apply for another no cost refinance and further your monthly savings.
When you have two loans, but you wish to refinance your first only, the second lien holder (lender) must agree to “subordinate” (to put their loan behind the new first loan). In this way, your first loan can be modified without affecting your second. Generally, second lien holders are adverse to subordinating their loan unless the refinance on your first is going to lower your payment while allowing your payoff balance to remain consistent or to decrease. Without a subordination, the new first lien holder could lose much of their security and would almost certainly refuse the refinance.