How Does Mortgage Refinance Work?

by John Stapel

Refinancing your mortgage can save you money, build equity in your home, and leave you with a more stable and manageable payment plan. But is it worth it? Refinancing comes at a price. Here, we cover the mortgage refinance basics, benefits, and drawbacks. We’ll also explain the refinancing process and how to find a deal that works for your financial profile.

Several different types of refinance loans are available – you’ll see the options in the table below. Further on, we’ll cover each of these mortgage refinance products in more detail.

Type of Mortgage Refinance What it does Who qualifies Rate-and-term Changes your interest rate or length of loan term Homeowners in good financial standing and with a healthy credit score (usually 600+) Cash-out Gives you cash Those who have enough home equity to borrow against it Streamline Avoids the appraisal process People who have an FHA or VA mortgage loan No-closing cost Cancels out closing fees Homeowners who can afford larger monthly payments Cash-in Builds up home equity Those who can afford to pay a large sum Low-income enterprise Offers low rates and term changes to low-income borrowers Homeowners who have a mortgage with Fannie Mae or Freddie Mac

Mortgage Refinance Explained

What is a mortgage refinance ?

When you swap out your old home loan for a new one, you’ve refinanced your mortgage. Most people refinance to save money or reduce their monthly payments, although there are other scenarios in which refinancing makes sense, too.

According to credit reporting agency Equifax, “There are several reasons to  refinance a mortgage . The most common are to reduce the interest rate (which decreases the amount of money paid to the bank), to shorten the duration of the loan, and to switch between a fixed-rate and adjustable-rate mortgage (ARM).”

Here’s a quick mortgage refinance guide to these and some of the other reasons why you might decide to refinance:

  • To reduce your interest rate

Your interest rate is based on a few things: the state of the economy, where mortgage refinance rates are in general, and your personal financial history, among others. When the federal rate drops or your credit score improves, you may qualify for a reduced interest rate on your home loan.

  • To change the term of your mortgage (the length of time you pay it back)

You can either shorten or lengthen your mortgage term. If you shorten it—say to a 15-year loan—you’ll build equity faster and own your home sooner. However, your monthly payment may be higher.

If you want to lower your monthly payment, you can refinance to a 30-year loan. Borrowers who wish to refinance mortgages based on term should do a 30 vs. 15-year mortgage comparison .

  • To free up money

If you need a lump sum of money, you can refinance your mortgage and borrow the cash against your home equity. You usually need to have paid off at least 20% of your home loan before you’ll be approved for this type of refinancing. This is an option borrowers use to make home improvements or pay large medical expenses and other types of debt.

A cash-out loan usually has higher interest rates and comes with a greater foreclosure risk. Keep in mind that you may have less risky options for obtaining that cash.

  • To switch from an ARM to a fixed-rate loan

When you qualified for your original loan, it might have been under an ARM. If you have an ARM, your interest rate isn’t fixed, which means it fluctuates based on the index rate. Since that rate can increase, you might want to refinance to a fixed-rate mortgage to have more stable and predictable repayments.

When does it make sense to refinance a mortgage?

When to refinance your mortgage depends on your goals and financial situation. If you can reach your break-even point, it may be a good option for you. 

As TransUnion explains, “Your break-even point is when the savings you will have earned with a lower, refinanced interest rate are greater than the costs you will have undergone to refinance.”

To find out what your break-even point is, divide the total cost of the refinancing loan you’re considering by the monthly savings you would make.

For example, let’s say your refinancing fees are $2,000 and you would save $200 per month by taking the loan and lowering your interest rate. Simply divide 2,000 by 200. Your break-even point is 10 months. If you continue to live in the home you’re refinancing for more than 10 months, you’ll save money, and refinancing may be worth the effort.

Other factors to consider before applying to refinance:

  • Your credit score

Do you know how credit scores affect mortgage rates ? Some lenders reject refinance applications based on low scores, which can be anything below 600. Even if your application is approved, your credit score will influence the interest rate you pay.

  • Federal interest rates

If current mortgage refinance rates are high, you may not want to refinance. In this case, even someone with a good credit score may not get a low-interest rate. A mortgage refinance calculator can help you figure out what the rate is likely to be.

  • How long you plan to stay in the house

If you aren’t staying in your house for more than a few years, refinancing your mortgage may not save you any money, as you may not reach your break-even point.

  • The value of your home

If the housing market is slow, then it might be difficult to find a loan that gives you a better deal than your current mortgage.

  • The amount of equity you have in your home

You can qualify for a refinance if you have at least 20% home equity.

  • Frequent changes in refi rates

Even during the refinancing process, you may see interest rates fluctuate higher or lower. Unless you lock in your rate, you could end up with one higher than when you initiated the refinance.

Pros and cons of refinancing your mortgage

There are several potential benefits to refinancing your loan:

  • Lower monthly payments

If you qualify, you may be able to pay a lower interest rate. This would lower your monthly payments and help you build equity in your home faster.

  • Own your home sooner

When you shorten the length of time over which you pay back your loan, you get on course to own the house outright sooner. You’ll also pay less interest overall.

  • Stabilizing your interest rate

If you refinance your mortgage to a fixed-rate loan, you won’t have to deal with higher repayments due to fluctuating interest rates.

  • Settling debts or paying for large expenses

You can borrow against your home’s equity. This could free up some cash to pay off debts or make large purchases.

Unfortunately, there are some downsides to refinancing your mortgage, too:

  • It takes a long time

The refinance process is lengthy and time-consuming. You could spend a lot of time searching for and securing a competitive rate. It may be more trouble than it’s worth.

  • You could pay more

You may not break even or may end up paying more per month if you choose to shorten the term of your loan.

  • Your credit score could drop

Refinances sometimes show up on your credit report as a new loan. You could also end up with multiple hard inquiries on your credit report if you shop around. Every lender performs a hard check on your score.

Now that we’ve covered the basics of how to refinance a mortgage, let’s look at the different home loan refinance products in more detail.

Types of mortgage refinancing products

There are six different types of refinance loans available to homeowners. To figure out which option works for you, you should first analyze your financial situation.  

Here’s what you need to know about each option:

  • Rate-and-term

Obtaining a new, more favorable rate and/or a different loan term are among the most common reasons for refinancing. You can also switch from an ARM to a fixed-rate mortgage. Homeowners with good credit scores generally qualify to benefit from this type of loan.

  • Cash-out

With this option, you replace your current mortgage with a higher loan and receive tax-free cash by borrowing against your home equity. You should have at least 20% home equity established before you’ll qualify for this option.

  • Cash-in

Typically, home refinance is similar to zero down and low downpayment loans , in that you don’t need to put money down to secure it. However, cash-in refinance is the opposite. This is where you put down money in the hope of refinancing for a lower interest rate soon. For example, if you had a $200,000 mortgage and had only paid $5,000 so far, you could pay a lump sum to extend your home equity. You may then qualify to refinance later at a lower interest rate.

  • No closing costs

With this type of loan, lenders waive closing fees. But those fees may be included in the principal, resulting in higher monthly payments.

  • Streamline

If you choose a streamlined option, your original loan paperwork is used to make the process go faster. You must have a Federal Housing Administration (FHA) or Veterans Affairs (VA) mortgage to qualify.

  • Low-income enterprise

Before 2021, low-income borrowers had few options to refinance. Now they may qualify to save money by refinancing. You must have a mortgage with Fannie Mae or Freddie Mac to qualify.

Cost and timing during mortgage refinance

A home refinance takes approximately 30 to 45 days to complete. There are fees included in this process. Closing costs are usually 2% to 6% of your loan balance.

Below are some examples of the fees associated with a mortgage refinance:

  • Origination fee

This goes to your lender for preparing the mortgage.

  • Appraisal fee

This covers the cost of the appraisal to evaluate your home’s worth.

  • Application fee

This covers the administrative costs of the application process.

  • Escrow fee

You may be required to put money in escrow to cover things such as insurance and taxes.

  • Lender fee

These fees cover things like wire transfers and clerical costs.

  • Inspection fee

Just as you had to pay an inspection fee when you first purchased your home, you may have to get another inspection done.

  • Title search

You may have to pay a fee for a title search to verify your ownership of your home.

  • Attorney fee

This closing cost pays your lawyer for conducting the closing.

  • Homeowner’s insurance

You’ll probably need to have homeowner insurance to protect against physical damage to your house.

Remember to research your options, negotiate to get a more competitive deal, and get everything the lender offers you in writing. Occasionally, lenders waive some of these fees. As a reminder, you can apply for a no-closing cost loan, but your monthly payments will likely be higher.

How does mortgage refinancing work?



Refinancing isn't as complicated as it may sound—essentially, you're swapping out your old home loan for a new one, and the process is like the one you went through when you got your current mortgage. Once you've applied to a lender for refinancing, they will verify your employment status and financial documents. You'll most likely have to have your house appraised as well.

When to refinance a mortgage?



It depends on your financial goals and how long you plan on staying in the house. Contact a financial planner to learn your options.

Is mortgage refinancing worth it?



It depends. Your refi rate should be a deciding factor. Your credit score could drop, and the life of your loan may extend. If your new rate counters those effects, it may not be worth refinancing at all. Speak to a financial consultant if you need advice about refinancing your mortgage.

How much does a mortgage refinance cost?



Refinancing your mortgage costs closing fees. Homeowners looking to refinance their loan should make sure that the lower monthly payment offsets these closing costs.

Final Thoughts on Mortgage Refinance

If you’ve reviewed your financial goals and decided it’s the right time to refinance, your next step is to find the best mortgage refinance lenders.

There are some other things you should do, too:

  • Know what your home is worth

The internet’s estimate of your home’s value isn’t always accurate. You should learn the fair market value as reported by your local tax commissioner. It’s also a good idea to get a sense of how much other homes in your neighborhood are worth—that plays a role in your own home’s value.

  • Protect your credit score

Make your payments on time, pay off debts, and make any other positive financial changes you can.

  • Get your home ready for an appraisal

Your house is likely to be appraised as part of the refinance process. You may want to make some changes to your home, such as repainting and cleaning your basement.