Foreword

Refinancing

1. Banking. A loan that adds to the principal balance owed, usually for property or home improvements, and alters the payment amount and terms.

2. Finance. Issuing new securities at a lower interest rate, or extended maturity. Also called Refunding.

3. Real estate. To extend existing financing to new properties.

4. Mortgages. Revising a mortgage loan and modifying scheduled debt payments, often to reduce finance charges or to modify the loan payments.

Mortgage Refinancing

Owners of residential or commercial real estate use a similar method to analyze their refinancing decisions. In residential real estate the conventional wisdom applies the "2-2-2 rule": if interest rates have fallen two points below the existing mortgage, if the owner has already paid two years of the mortgage, and if the owner plans to live in the house another two years, then refinancing is feasible. However, this approach ignores the present value of the related cash flows and the effects of the tax deductibility of interest expense and any related points.

Therefore, a better analysis of a mortgage refinancing decision should be conducted as follows:

1) Calculate the present value of the after-tax cash flows of the existing mortgage;

2) Calculate the present value of the after-tax cash flows of the proposed mortgage;

3) Compare the outcomes and select the alternative with the lower present value.

The interest rate to be used in steps one and two is the after-tax interest cost of the proposed mortgage. Paying off an existing loan with the proceeds from a new loan, usually of the same size, and using the same property as collateral. In order to decide whether this is worthwhile, the savings in interest must be weighed against the fees associated with refinancing. The difficult part of this calculation is predicting how much the up-front money would be worth when the savings are received. Other reasons to refinance include reducing the term of a longer mortgage, or switching between a fixed-rate and an adjustable-rate mortgage. If there are prepayment fees attached to the existing mortgage, refinancing becomes less favorable because of the increased cost to the borrower at the time of the refinancing.

Some of the related terms for Mortgage refinancing are:

• Financing
• Balloon Loan
• Rate-Improvement
• Refund
• Floating Debt
• Prepayment Risk
• Rollover Mortgage

Sometimes refinancing involves the issuance of equity in order to decrease the proportion of debt in the borrower's capital structure. As a result of refinancing, the maturity of the debt may be extended or reduced, or the new debt may carry a lower interest rate, or some combination of these options. Refinancing may be done by any issuer of debt, such as corporations and governmental bodies, as well as holders of real estate, including home owners. When a borrower retires a debt issue, the payment is made in cash and no new security takes the place of the one being paid off. The term "refunding" is used when a borrower issues new debt to refinance an existing one.