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What is mortgage refinancing? How it works and when you should consider it

October 28, 2022, 3:00 PM UTC
Photo illustration of a yellow house with a calculator as the front door.
Refinancing could help you lower your monthly payment and change your mortgage terms.
Photo illustration by Victoria Ellis/Fortune; Original photos by Getty Images

The journey to homeownership isn’t always a simple one, and it doesn’t end the day you receive your keys. Once that day arrives, there are still usually anywhere from 15 to 30 years of mortgage payments ahead of you. You can expect a few changes in that time, especially as it relates to your finances. 

When that happens, you might consider refinancing your mortgage. 

What is mortgage refinancing? 

When you refinance your mortgage, you’re taking out a new loan to pay for your existing mortgage. The difference: This new loan will have new (and hopefully better) terms. A few major reasons you may consider refinancing your mortgage: 

  1. It could lower your monthly payment: When you refinance to a loan with a lower interest rate or a longer term, it could shave quite a bit off the top of your monthly mortgage payment, making it easier for you to repay it, as well as cover your other expenses and debts. 
  2. You’ll pay less in interest over the life of your loan: When the interest rates drop, you could find yourself in a position to secure a lower rate, which could translate to major savings between now and the end of your term. 
  3. You could gain access to your home equity: Also known as a cash-out refinance, this is when you replace your existing mortgage loan with a new one that has a larger balance. Then you take the difference in the form of cash and use it to fund other costly expenses or projects. 

How does mortgage refinancing work? 

Refinancing takes about 30 to 60 days, and the process itself is similar to the process you went through when you applied for your original mortgage, so aim to be prepared by gathering all of your important financial documents ahead of time so that the process can be as seamless as possible. 

“The lender will need to review your financial condition again to determine your ability to repay the new mortgage and will reevaluate your home to obtain an updated property value,” says Thomas Parrish, managing director and head of retail lending product management at BMO Financial Group. “You will need to provide various documentation (income docs, asset statement, property insurance policy, etc.) to your lender. Based on evaluating all these aspects your lender will determine if you qualify for a new mortgage.”  

Pro tip: Get a preapproval from multiple mortgage lenders so you can compare interest rates and terms and choose the most favorable option. 

Refinancing—by the numbers 

So how much can you actually save by refinancing? Let’s break it down. 

Say you have a 20-year fixed-rate mortgage of $300,000 and you still have 15 years remaining on your loan: 

Your interest rate: 6% (the current national average for a 30-year fixed-rate loan is 7.04%). 
Monthly payment: $2,200
Balance left on your mortgage: $270,000

Now let’s say you refinance to a 15-year mortgage (around the same amount of time you had left on your original loan) for a lower rate. 

Your new interest rate: 3.5% 
New loan term: 15 years 

Lowering your interest rate and choosing a 15-year term will help you save the following: 

Your new monthly payment: $1,930.18
Monthly savings: $269.82 
Difference in interest: $48,567 

Want to try crunching the numbers yourself? Try using our mortgage refinance calculator below:

What are the pros and cons of refinancing? 

Many experts agree that if refinancing your mortgage could help you save at least 1%, it may be worth all the extra paperwork and fees. But if the savings aren’t significant, you might be better off sticking with your current mortgage and original terms. Here are some of the pros and cons you should weigh when considering refinancing: 

Pro: You could lower your monthly payment. Once of the obvious benefits of refinancing your mortgage is that you could secure a lower interest rate that would, in turn, lower your monthly payment. 

Pro: You could get rid of your private mortgage insurance (PMI). If you made a smaller down payment when you originally purchased your home, you may be responsible for monthly PMI payments now to make up for the risk your lender assumed when lending you the funds for your home. Refinancing can be one way to get rid of this requirement. The cost of PMI varies based on a number of factors, but generally, Freddie Mac estimates it costs between $30 and $150 per month for every $100,000 borrowed.  

Con: You’ll be responsible for closing costs. Refinancing isn’t free—so you’ll need to crunch the numbers to figure out if you’ll actually save enough to make these added costs worth it. When you refinance, you’ll be responsible for closing costs…again. This could range anywhere from 2% to 5% of your refinance’s value. “Some aspects homeowners should keep in mind when refinancing are the costs associated with it,” says Parrish. “Typically, [there are] closing costs such as loan origination fees, appraisal fees, title searches and insurance, surveys, recording fees, closing attorney’s fees, and taxes.” 

Con: Refinancing doesn’t always help you save. If you have plans to move or can’t secure a low enough rate, refinancing may actually cost you more than you can save. For example, if refinancing your loan with a new lender costs $5,000 upfront, and your new monthly payment is only $50 lower than what you were previously paying, you'd need to stay in your home for at least 100 months to breakeven.

The takeaway 

Refinancing isn’t a cure-all for your housing cost woes. It can help some homeowners trim their expenses, but your financial circumstances and the rates being offered to you will play a huge role in whether or not you should try to refinance your mortgage. 

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