The 8 Most Misunderstood Refinancing Terms

If you are having trouble keeping to your budget or at least making your monthly mortgage payments, you may have thought about (or been told to think about) refinancing. Homeowners often refinance their mortgage to secure a lower interest rate, shrink their monthly payments or change the length of the loan. But before you start crunching numbers and contacting lenders, it’s important to understand how refinancing works. Check out the below glossary of frequently misunderstood refinancing terms to help you get started.

1. Mortgage Balance

Probably the first figure you should look at while in the decision process, the mortgage balance is the full amount owed at any specific time during the life of a mortgage. It is the sum of the remaining principal you have and any accrued interest.

2. Cash Out

To capitalize on the equity you’ve built in your home, you can take some for yourself as cash payment when you close on your refinance. You will increase your mortgage balance and likely even your monthly payment depending on the specifics of your mortgage but it can give you liquidity if you need it in an emergency.

3. LTV Limit

Loan-to-value or LTV limits are limitations lenders usually impose on your ability to refinance. This ratio compares the amount you still owe on your mortgage to the current estimated value of your home. These limits are generally set by government or government-sponsored agencies that buy mortgages.

4. Mortgage Insurance

Mortgage insurance can help provide peace of mind to your lender because you pay the premiums and they are the beneficiary. This coverage protects lenders against borrower defaults and if you are refinancing with a high LTV limit and you have a long way to go in the life of the loan, your lender may require it. Once you get back on track, you can work with your lender to drop the insurance premiums.

5. Origination Charge

This fee is the amount your lender charges for the administrative costs associated with a mortgage or refinance application and processing.

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6. Points

Points are a form of prepaid interest premiums. One point is generally equivalent to 1% of the total loan amount. When you refinance, you can use this upfront payment to the lender and reduce the interest rate on the loan and therefore your monthly payment.

7. HARP

The Home Affordability Refinance Program (HARP) is a program sponsored by the Making Home Affordable Act that allows homeowners with Fannie Mae- or Freddie Mac-owned mortgages to refinance at favorable rates despite having little equity.

8. Mortgage Taxes

You may remember these from your first mortgage. These are taxes levied by state and or local governments on every new mortgage created. Since refinancing is basically the same as taking out a new mortgage, you will probably have to pay a mortgage tax again, just as when you acquired your original loan.

Now that you have a better understanding of the vocabulary, it’s a good idea to take the time to really learn about the process of refinancing — how it works, what changes it can cause and ultimately, if it is the right move for you. Keep in mind that a good credit score is important for any homeowner looking to refinance — it will help determine your interest rate and can save you thousands of dollars over the lifetime of the loan. You can check two of your credit scores for free on Credit.com to see where you stand.