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How Does Refinancing a Mortgage Work?

Owning a home is a great investment in your future and the easiest way to finance that purchase is with a standard mortgage loan. While those loans can last for decades, you’re not necessarily stuck with the same loan you took out originally. Instead, you can refinance your mortgage.

Believe it or not, an estimated 6.5 million homeowners can benefit from refinancing their existing mortgage. However, if you’re new to the process, you’re likely asking yourself, “how does refinancing a mortgage work and is it really right for me?”

Though every financial situation is different, refinancing your home loan can often save you money. Here’s what you need to understand about refinancing a mortgage so you can make the best decision for your needs.

Refinancing Means Taking Out a New Loan

When you refinance your current mortgage, you’re not making changes to the original loan term, though it can feel like you are. You’re actually taking out an entirely new mortgage.

Taking out a new loan allows you to take advantage of lower interest rates or leverage your improved finances to get better terms on a loan. Remember, when you applied for your original mortgage, you got locked into the rates and terms for the length of the loan.

The only way to change those terms is to pay that original loan off and take out an entirely new mortgage. When you refinance, you’ll use the money you receive from your new loan to pay off your original loan.

Once the original loan gets paid off, you’re locked into the rates and terms of the new loan until you either refinance again or pay the loan off in full.

Why You’d Want to Refinance

The most common reason that people start trying to figure out how to refinance a mortgage is to take advantage of lower interest rates. It’s normal for interest rates to fluctuate from year to year, but when they’re significantly lower than the interest you’re paying on your current loan, refinancing can save you money.

Though this is the most common reason, it’s not the only reason people consider refinancing their home loans. Doing so can also free up cash to cover home repairs or change the length of your loan term to give you lower monthly payments.

If you’re not sure if refinancing is in your best interest, think about what you want to accomplish by taking out a new home loan.

Are you looking to pay down higher-interest debts? Have your finances improved since you got your original mortgage? If so, refinancing is a great option.

However, if refinancing won’t make your monthly finances easier to bear or will end up costing you more focus on paying down your current loan quickly. Check out https://jaketaylor.com/how-to-pay-off-your-mortgage-sooner/ for helpful tips to make that happen.

What to Expect When You Apply

When you apply to refinance a mortgage, you’ll essentially be applying for an entirely new loan. This means you’ll need to go through the standard application process once again.

The requirements for each loan vary from lender to lender. However, most require that you provide copies of your W-2 or end-of-year wage statements, bank statements showing your personal financial situation, and information about your current loan.

Some lenders may also require additional documentation, but they’ll let you know what they need when you start the process.

No matter who you go with, you can expect lenders to run a hard credit check to see where your score lies. This credit check can hurt your credit score, causing it to drop by a few points. However, it shouldn’t be enough to hurt your chances of qualifying for refinancing.

Start With Your Current Lender

Though it’s always a good idea to shop around for a new loan, the best place to start is with your current lender. Let them know that you’re interested in refinancing your mortgage. Often, your current lender will offer you more competitive rates and may charge you lower fees if you refinance your home with them.

That said, you should do your due diligence and see what other banks, credit unions, and mortgage brokers are able to do for you. Get quotes from at least a few other lenders and compare the rates closely.

You’ll want to choose the lender that offers you the best deal on your new loan and charges the fewest fees possible.

What Risks You’ll Face If You Refinance

As with any loan, there are risks to mortgage refinancing that you need to know before you commit to the process. This will make it easier for you to weigh the pros and cons of a mortgage refinance.

First, when you refinance your home loan, you start the loan term over. This means that if you refinance your 15-year mortgage with a 30-year loan, the 30-year term starts the day you close on the loan. You’ll be in debt for longer if you don’t pay the loan off early.

You’ll also have to pay for the full amount of fees and closing costs for the loan. The fees you paid on your original mortgage will not carry over. If you don’t have the funds on-hand, this can put a serious strain on your budget.

Your current lender may also charge you a fee to refinance even if you don’t refinance through them. The amount of the fee will vary from lender to lender, so make sure to read up on your loan agreement before you start the process.

So, How Does Refinancing a Mortgage Work?

Now you should have a better understanding of mortgage refinancing and can answer the question, “how does refinancing a mortgage work?” If you’re considering refinancing your current home loan, think about your personal financial situation before you start looking at your options.

If you think that refinancing can benefit your budget and improve your finances, it’s worth considering. Just make sure to speak with several lenders before you make your decision.

Once you refinance, you’re locked into that new loan for the full term. Make sure it fits your needs and your budget before you accept the money.

For more helpful tips to make staying on budget every month easier, check out our latest posts.

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