Refinancing Explained

Refinancing is when you take out a new loan (with a new lender or your current lender) to pay off your existing mortgage. There are three primary reasons for refinancing your mortgage, including:

  1. to lower your monthly payments
  2. to shorten the term of your mortgage and own your home sooner
  3. to take cash out

When you refinance a mortgage, you have to go through many of the same steps as when you took out the original loan. This includes shopping around for a lender and better loan terms and then submitting a loan application and relevant financial documents, such as proof of income, tax returns, bank statements, investment account statements, employer contact information and information about other debt, such as car loans and student loans.

You’ll also incur many of the same costs, including closing costs, fees, taxes and the expense of paying for a new house appraisal. Refinancing generally costs a percentage of the loan principal. It’s important to be sure that the savings you’ll reap from refinancing will offset these costs. This calculator can help you determine how long it will take to break even on closing costs when you refinance.

When to Refinance

Generally, it makes sense to refinance a mortgage when you find yourself in one of these situations:

You can obtain a lower interest rate. If interest rates have decreased by a percentage or two since you took out your first loan, you may be able to save money over the life of the loan by switching to a loan that has a lower interest rate. You’ll also lower your monthly payments.

You want to change how your lender charges mortgage interest. If interest rates are increasing, periodic adjustments to interest rates on adjustable-rate mortgages (ARMs) eventually can lead to a higher rate than what is being offered on fixed-rate mortgages. Switching from an ARM to a fixed-rate mortgage could save you money. Conversely, you may want to go the opposite route if interest rates are steadily dropping.

You want to consolidate mortgage debt. You can combine a first mortgage and a home equity loan into one loan with one monthly payment.

You’ve improved your credit score. You may qualify for a more favorable loan interest rate or loan terms after you’ve made some on-time payments and boosted your credit score. 

You need to reduce your monthly payments. If you’re having financial difficulties, refinancing allows you to extend the length of the loan and thereby lower your monthly payments to an amount that is more manageable. 

You want to tap into your home’s equity. With a cash-out refinance, you take out a loan to pay off your existing mortgage and extra cash in a lump sum that you can use toward a house renovation, college education or other expenses. It’s different from a traditional home equity loan because you’re taking out a new loan altogether for your existing mortgage balance and then some. A cash-out refinance may be a good option if you want cash but also want to lower your current interest rate.

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