How does refinancing a mortgage work?

Mortgages are long-term commitments—often as long as 30 years. And a lot can change in that time. But once a mortgage is signed, the agreement typically remains the same.

However, a process known as mortgage refinancing might enable homeowners to find a better deal to do things like shorten the length of their loan, improve their interest rate, access equity and adjust other terms.

Key takeaways

  • Homeowners may refinance their mortgages to do things like secure a lower interest rate or shorten their loan term.
  • There are several steps to refinancing a mortgage, including submitting an application and getting a home appraisal.
  • To determine if refinancing is right for you, you can crunch the numbers and shop around for the best rates and terms.

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What is refinancing and how does it work?

Refinancing a loan means getting a new loan to replace the existing one. In the case of refinancing a home loan, it means getting a new mortgage. This new mortgage then pays off the balance of the old one.

The process typically includes applying with a lender or lenders, undergoing a home appraisal, going through the underwriting process and closing on the loan. 

Reasons why some may consider refinancing a mortgage

There are multiple reasons why someone might refinance their mortgage:

  • Better interest rate: You may be able to save money on your mortgage loan with a lower interest rate. If rates are lower now than they were when you initially took out your loan, then refinancing can lower monthly mortgage payments. 
  • Shorter loan term: Refinancing to a shorter term—like going from a 30-year mortgage to a 15-year mortgage—may help to pay off the loan faster. Plus, it can save money on interest over the life of the loan. Keep in mind, this may result in higher monthly payments. 
  • Change loan type: Refinancing a loan can switch it from an adjustable-rate mortgage to a fixed-rate mortgage. An adjustable-rate mortgage has an interest rate that changes depending on market conditions. With a fixed-rate mortgage, the interest rate stays the same throughout the length of the loan. Switching to a fixed-rate mortgage can be beneficial if rates are increasing or if you want a more predictable monthly payment.
  • Tap into home equity or consolidate debt: It may be possible to tap into the home equity—or the difference between the home’s value and what’s owed on the loan—to cover large expenses like home upgrades or to consolidate debt. If there’s enough home equity in the property, one option is a cash-out refinance. That’s when you use the equity you have in your home to borrow more than you owe on your loan. You can then get cash for the difference.

How to refinance a mortgage in four steps

To refinance a mortgage, it can be helpful to understand the process and know what to expect. Here are some of the potential steps. 

1. Apply

In many cases, the first step is submitting an application with a lender or lenders. It’s a good idea to shop around and compare rates and terms. And it might be worth considering the current lender if they offer potential savings.

During the application process, lenders might ask for documents, such as:

  • W-2 forms
  • Recent pay stubs
  • Recent bank statements
  • Tax returns
  • Employment history

2. Prepare for a home appraisal

Lenders typically require a home appraisal when refinancing a mortgage. To figure out how much a home is worth, an appraiser will visit and assess it for certain criteria, including how the home compares to market trends and recent sales of similar homes in the area. 

3. Go through the underwriting process

The underwriting process begins after the application and appraisal are completed. During the underwriting process, a lender will verify the information submitted and make sure it’s accurate. They will then finalize the loan decision. 

Underwriting typically takes a few days to a few weeks to complete. After the loan is approved, a lender might offer to lock in or float down the interest rate. 

A locked interest rate will remain the same for a specific amount of time—typically during the underwriting process. The rate lock could also have a float down option. Floating the rate means locking it in but having the option to get a lower rate if the rates fall. Keep in mind, both options may come with a fee. 

4. Close the loan

The last step is to close on the mortgage loan, sign the new loan documents and pay any closing costs.

Things to do before refinancing your mortgage

For a smoother mortgage refinancing experience, it can help to be prepared:

  • Review your credit score and history. Lenders typically review applicants’ credit. Higher credit scores could result in better refinance rates and terms offered by lenders. If possible, it can be helpful to take steps to improve your credit before applying for a mortgage refinance.
  • Shop around with different lenders. Comparing interest rates, loan terms and fees could help you find the best deal. After you apply, you should receive a loan estimate document from each lender, which can provide specific details about the potential loan.
  • Use a mortgage refinance calculator. A refinance calculator can help you gauge refinancing costs and compare potential savings. When using a refinance calculator, you’ll plug in information like your estimated interest rate, new loan amount and other costs—like origination fees, appraisal costs and taxes. This can help you determine your refinance break-even point, which is how long it will take to make up the refinancing costs of your old mortgage with the savings from the new one.

Mortgage refinancing FAQs

Still have questions about mortgage refinancing? Here are some answers to frequently asked questions.

Does refinancing hurt your credit score?

Refinancing can temporarily affect credit scores. That’s because mortgage lenders typically carry out a hard credit check during the application process. A hard inquiry might shave off some points from an applicant’s credit score, and multiple inquiries can affect it even further. But if they’re done within a certain amount of time—like 45 days—they may be counted as a single inquiry. 

What are the downsides of refinancing?

Although there are potential benefits to refinancing a mortgage, there can also be some downsides. So it’s a good idea to do your research to see if it’s right for you. Some considerations to keep in mind include:

  • Closing costs and other fees on the new loan.
  • Increased monthly payments.
  • Refinancing to consolidate debt can turn unsecured debt into debt that’s backed by a home, which is the collateral that backs a mortgage. 

What does an appraiser look for during refinancing?

When you’re refinancing, appraisers may consider recent sales of similar homes in the area or sales of comparable properties. But they also generally look for the following in your home:

  • Number of rooms
  • Functionality and design
  • Amenities like porches, decks and pools
  • Improvements and upgrades
  • Age of the systems and utilities in the home
  • Location of home
  • Interior and exterior conditions

Refinancing a mortgage in a nutshell

Running the numbers and comparing different lenders can help you find a mortgage refinancing option that works best for you. But it’s a good idea to consider your goals, your financial needs and the potential pros and cons before you commit to mortgage refinancing. 

If mortgage refinancing is something you’re interested in, learn more about how to find out your home’s value. This could give you more insight as you move through the refinancing process.

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