How Does Refinancing a Mortgage Work?

Refinancing your mortgage is a strategic move that can put you, as a homeowner, in better control of your financial future. A refinance can lower your interest rate, reduce your monthly payments, enable you to drop your mortgage insurance, or even provide cash for home improvements and other expenses. 

With the right timing and the right loan, refinancing can be a smart way to make your mortgage work better for you. But how does refinancing a mortgage work? Is now the right time to consider a refinance? In this post, we explore these and other questions to help ensure you make the best decision for your situation. 

Key takeaways 

• Mortgage refinancing allows homeowners to replace their existing loan with a new one — often with better terms. 
• The refinancing process involves setting a goal, comparing lenders, gathering documents, applying, and closing on the new mortgage. 
• Different types of financing exist, including rate-and-term, cash-out, and cash-in refinancing. 
• Pros and cons of refinancing depend on factors like interest rates, loan terms, and closing costs. Homeowners should assess their individual situation to determine if refinancing is the right move. 

What is mortgage refinancing? 

Mortgage refinancing is the process of replacing your current home loan with a new mortgage — usually with different and more favorable terms, interest rates, or payment structures.  

One of the most common reasons to refinance is to secure a lower interest rate, which can reduce your monthly payments or shorten the term of your loan, saving thousands in interest over time. Some homeowners refinance to switch from an adjustable-rate mortgage (ARM) to a fixed-rate loan, ensuring a more predictable payment structure.  

Refinancing can also be a way for homeowners to tap into their home’s value. A cash-out refinance replaces your existing mortgage with a larger one and lets you take the difference in cash for home improvements, debt consolidation, or other expenses.  

Regardless of the reason, refinancing provides a way for homeowners to adapt their mortgages to better fit their financial goals. 

How does refinancing work? 

The mortgage refinancing process begins with assessing and understanding your financial goals, which will help you navigate the many loan options you have available. Here’s a step-by-step breakdown of how it works: 

1. Determine your goal 

First thing’s first: Why do you want to replace your current mortgage?  

Do you want to lower your interest rate, putting more money in your pocket each month? Are you interested in shortening the term of your loan? Do you want more predictable payments? Defining your goal will help you choose the right refinancing option and lender for your needs. 

2. Compare lenders and offers 

Be aware that not all lenders offer the same rates, fees, or loan terms. So, it’s essential you shop around and compare mortgage lenders before committing to a refinance. Look at interest rates, closing costs, loan terms, and lender reviews to help ensure you secure the best possible deal. 

3. Gather the right documents 

Lenders require that you produce several documents to process your refinance application. This includes: 

• Proof of income: Pay stubs, W-2s, tax returns. 
• Credit report and score: Lenders will pull this. 
• Current mortgage statement: Shows your loan balance and terms. 
• Bank statements: Used to verify your assets and reserves. 
• Debt and liability info: Includes credit cards, auto loans, and other debts. 

Being prepared to provide these documents can streamline the refinance process and prevent delays. 

4. Apply for your loan

Once you’ve chosen a lender, it’s time to submit your application. The lender will verify your income, credit, and home value while processing your loan. Beyond this, how does refinancing a home loan work behind the scenes? 

First, underwriters will review your documents, assess risk, and ensure you meet their loan requirements. If approved, you’ll receive a loan estimate that outlines terms and closing costs. You can help this process go smoothly by quickly responding to any lender requests for additional information or documentation. 

5. Close on your new mortgage

When your loan is approved, the final step in refinancing your mortgage is to review and sign closing documents — the new loan agreement, closing disclosure, and other legal paperwork. You may also need to pay closing costs unless they’ve been rolled into your new loan. 

After signing, there’s a three-day rescission or cancellation period (for most refinances) before new loan funds officially replace your old mortgage. 

Types of mortgage refinancing to consider

Mortgage refinancing isn’t a one-size-fits-all solution. Different refinancing options work differently to cater to different financial goals. So, whether you want to lower your interest rate, tap into your home equity, or adjust the term of your loan, understanding the types of refinancing available can help you choose the best option for your situation. 

Here are some of the options you have available when considering refinancing your mortgage: 

Rate-and-term refinancing 

The most common way to refinance, these loans allow you to secure a lower interest rate or adjust the term of your mortgage. The primary goal here is typically to reduce monthly payments and/or pay off the loan faster. Switching from a 30-year to a 15-year term, for example, could save you thousands in interest over time. 

Cash-out refinance

These loans enable homeowners to refinance for more than the outstanding loan balance, then receive the difference in cash. A cash-out refinance is most appropriate if you’re looking to tap into your home’s equity for home improvements, debt consolidation, or other significant expenses. Doing this, however, increases your loan balance and may result in higher payments. 

Use our Cash-Out Refinance Calculator to see how different scenarios affect your monthly payment. 

Cash-in refinance 

For this option, homeowners pay a lump sum toward the loan’s principal during refinancing, reducing the overall loan balance. This approach can help eliminate the need for private mortgage insurance (PMI) or help you qualify for better loan terms thanks to increased equity. 

Streamline refinancing 

An option primarily for government-based loans (i.e., FHA or VA loans), streamline refinancing simplifies the process by requiring less documentation and no appraisal. It’s designed to expedite refinancing for borrowers with a good payment history who want to reduce interest rates or switch from an ARM to a fixed-rate mortgage. 

No-closing-cost refinancing

As the name implies, this option allows you to refinance without paying upfront closing costs. Instead, the lender might charge a slightly higher interest rate or roll the fees into the loan balance, allowing you to avoid immediate out-of-pocket expenses. 

Pros and cons of mortgage refinancing

Though refinancing your mortgage can offer significant financial benefits, the process still has potential drawbacks. Before deciding to refinance your mortgage, it’s important to understand how it works and weigh the following pros and cons: 

Pros of refinancing 

• Lower interest rates and payments: Reducing your rate can lower monthly costs and long-term interest expenses. 
• Shorter loan term: Paying off your mortgage in fewer years can save thousands in interest. 
• Switching from an ARM to a fixed–rate loan: Locking in a stable rate protects against future rate increases. 
• Accessing home equity: A cash-out refinance provides funds for home improvements, debt consolidation, or other expenses. 

Cons of refinancing 

• Closing costs: Fees can range from 2% to 5% of the loan amount. 
• Extended loan term: Refinancing to a longer term, or resetting your original term, may increase the total interest you pay. 
• Equity reduction: A cash-out refinance reduces home equity, which could impact your financial flexibility in the future. 

Is refinancing right for you? 

Refinancing can be a smart financial move, but it’s not right for everyone. The key is weighing the benefits against the costs based on your financial situation. 

Consider refinancing if interest rates have dropped, allowing you to secure a lower rate and reduce your monthly payments. If you want to pay off your mortgage faster, refinancing to a shorter term could save on interest. Homeowners with at least 20% equity may eliminate private mortgage insurance (PMI), while a cash-out refinance can provide funds for home improvements or debt consolidation. 

Before deciding, compare lenders, evaluate fees, and ensure refinancing aligns with your goals. An AmeriSave Mortgage Expert can help guide you through the process. Contact us today to see how refinancing could benefit you.  

Frequently asked questions 

What are the pros of refinancing?

Refinancing can lower your interest rate, reduce your monthly payments, shorten your loan term, or allow you to borrow cash from your home’s equity. It can also be used to convert an adjustable-rate mortgage (ARM) to a fixed-rate loan, stabilizing payments. 

Does refinancing impact my credit? 

Refinancing can cause a temporary dip in your credit score due to the hard inquiry during your loan application and the opening of your new loan account. As you make timely payments on your new loan, your credit can recover and even improve over time. 

When can I refinance my home? 

You can refinance your home at any time, but most lenders require you to wait six months after your original mortgage closes. To maximize your potential savings, refinancing is ideal when interest rates drop, your credit score improves, or you’ve built at least 20% equity to remove private mortgage insurance (PMI).