Refinancing Your Home Mortgage

The process of refinancing a home mortgage involves taking out a new mortgage in order to pay off any existing mortgages and loans secured by the home.

When most people refinance their homes, they do so with the intention of obtaining a lower interest rate or reducing their monthly payment. The refinancing process involves taking out a new home mortgage, and paying off existing mortgages and encumbrances with the proceeds of the new loan.

When refinancing, some homeowners will borrow additional amounts against their equity in order to pay other debts, make purchases, or pay for home improvements.

While it may seem like an easy decision to refinance a home, particularly if the interest rate on the new mortgage will be lower than the rates paid on existing loans, you should take care to ensure that your remortgaging decision is truly in your financial best interest.

Getting the Best Mortgage

Before you refinance, you should consider what else you might do with the money you will be applying to closing costs. Similarly, if you will be increasing your monthly payments to pay off your mortgage more quickly, what else might you do with the money that will go toward those increased payments? Sometimes you will get a better return by putting that money into a retirement account, money market account, or mutual fund than by refinancing your house.

You should also check to see if you are paying private mortgage insurance (PMI), and if you have enough equity in your home to cancel that insurance. The cost of PMI coverage can be substantial.

You should also check to see if you will have to pay a prepayment penalty if you refinance your existing mortgage. If you must pay a penalty, the size of the penalty will affect your determination of whether it is financially wise to refinance.

Interest Rates

The leading factor in most people's refinancing decisions is the prevailing interest rate. If rates have dropped since they originally mortgaged their homes, refinancing may allow them to obtain a lower interest rate and make smaller monthly payments.

Even when rates drop, mortgage closing costs and the change in your mortgage interest deduction must be factored into your refinancing decision.

  • As a general rule, you will benefit from refinancing when interest rates have dropped two or more points since you obtained your original mortgage.
  • Even if you are looking at a reduction of less than 2%, particularly if you have equity in your home, you may want to explore the possibility of refinancing. You can easily shop around for the best rates, both online and by phone.

When seeking a new mortgage, consider asking your prospective lender to "lock in" an interest rate for a certain period in case interest rates rise. Lenders will often lock in interest rates for forty-five to sixty days. Any commitment made by the lender to lock in the rate should be provided in writing.

Application Fees

If you must pay an application fee when you apply for a loan or mortgage, find out up front if the fee is refundable if you are not approved for the loan or if you choose to use a different lender.

Closing Costs

In addition to any mortgage application fee, when you apply for a home mortgage, significant costs will be incurred before the loan is closed. Typical closing costs include an appraisal fee, title fee, title insurance, survey fee, points, recording and transfer fees, and attorney fees. Before you commit to a mortgage you should press your lender to provide as much detail about these costs and fees as you can possibly obtain.

Even if you are promised a "no cost" refinance, you should keep in mind that costs are involved. You will pay those costs through an increased interest rate or higher loan balance. There's nothing wrong with considering a "no cost" deal, but you need to look carefully at what you will be paying - even if you are required to pay closing costs, if you look at the total cost of the loan you may find that another loan package is cheaper.

Charges for "Points"

Mortgage points, also known as discount points, are fees charged by a lender in exchange for providing a reduced interest rate on the loan. Generally speaking, the lower the interest rate for a loan the higher the number of points a bank will charge to issue the loan.

Points are negotiable, and the number of points charged will vary between financial institutions.

If a borrower purchases points to reduce the interest rate, it is generally advisable not to finance the points. If a borrower plans to finance points, the additional cost should be considered when evaluating the financial benefits of refinancing.

Should You Refinance Your Mortgage

Beyond the cost of refinancing, borrowers should consider their circumstances when determining whether it makes sense to refinance and how much they should borrow.

Duration of Residence

To benefit from refinancing your mortgage, you should ordinarily anticipate staying within your home for three more years. If you intend to move before that time, the closing costs from refinancing are likely to consume any savings you obtain from a lower interest rate.

Withdrawing Equity

If your home has appreciated since you bought it, when you refinance you may be tempted to get a larger mortgage and to pocket some of the equity in your home. Homeowners should be careful to avoid borrowing more than they can reasonably afford to repay, lest their homes become subject to foreclosure.

Choosing a Shorter Mortgage Term

When you refinance your home, you may consider obtaining a shorter mortgage term. Shortening the term could mean that, even if your payments don't change significantly, your home is paid off in fifteen or twenty years instead of thirty.

However, with many mortgages you may make payments toward the principal balance beyond the required monthly payment, giving you the flexibility of a smaller required mortgage payment while still enabling you to pay off your mortgage ahead of schedule.

Refinancing vs. Mortgage Renegotiation

Before refinancing,  consider exploring the possibility of renegotiating your loan with your existing lender. Although the interest rates available through renegotiation are usually above what you would obtain if you refinance, often the fees associated with a renegotiation will be significantly lower than those associated with refinancing,

Copyright © 2004 Aaron Larson, All rights reserved. No portion of this article may be reproduced without the express written permission of the copyright holder. If you use a quotation, excerpt or paraphrase of this article, except as otherwise authorized in writing by the author of the article you must cite this article as a source for your work and include a link back to the original article from any online materials that incorporate or are derived from the content of this article.

This article was last reviewed or amended on May 8, 2018.