Refinancing replaces your original mortgage with a new one. When you refinance, the first loan is paid off, and another is created.

Why Do People Refinance a Mortgage?

Homeowners may refinance for several reasons, including:

Lowering Interest Rates: Homeowners can refinance their mortgage if the rates decline. As people work and make more money, they can pay their bills on time, which increases their credit score. This helps people procure better interest rates, reducing their monthly payments.

Cashing out A Home Equity: Some people refinance a mortgage to take out equity from their home to make large purchases (like cars or vacation property), or to reduce credit card debt. Equity is the difference between the amount owed to the mortgage provider and the worth of the home. Many people make additions and improvements to their homes, increasing the value of the home. Doing this helps the homeowner take out significant home equity lines of credit while making mortgage payments as their home’s appraised value increases, and the balance owed on the mortgage decreases.

Changing Loan Structure: Adjustable-rate mortgages (ARMs) offer low initial monthly payments and are ideal for those who don’t plan to stay in their home for more than a few years. However, a homeowner who plans to reside in his/her home for good could consider shifting from an ARM to a fixed-rate mortgage (FRM). FRMs offer the homeowner the benefit of knowing how much the payment will be every month over the loan term as the amount doesn’t change.

People also refinance to change the duration of the loan and to get rid of mortgage insurance.

Costs Associated with Refinancing a Mortgage

The closing costs associated with a mortgage refinance include:

Application Fee: Lenders charge this fee to cover the cost of reviewing a borrower’s credit report, and the initial cost of processing the loan.

Points and Fees Associated with The Loan Origination: You will also be charged a loan origination fee for the lender’s work of preparing and evaluating your home loan. Points are prepaid financial fees which the lender charges at closing. One point is equal to 1% of the actual loan amount.

If you’re unsure about whether refinancing is right for you, use a mortgage refinance calculator to find out how much you can save by getting a lower interest rate.