How Refinancing Your Mortgage Works

The prospect of refinancing your mortgage can be exciting and terrifying at the same time. You’re probably wondering how refinancing works, how much money it can save you and if you’re eligible. It’s time to bust open the books and grab your financial statements — we’ll help you figure out if mortgage refinancing is the right move for you.

Why Would I Refinance My Mortgage?

Good question — refinancing your mortgage isn’t something you do on a whim. There are plenty of benefits to refinancing your mortgage, but it’s not for everyone. Here’s why people do it:

To get a better interest rate on your mortgage. If interest rates are lower now than they were when you got your home loan, refinancing can allow you to take advantage of them. That could mean paying off your mortgage sooner, or taking the same amount of time (or longer) to pay it off with smaller monthly payments.

But snagging an interest rate that’s only slightly lower may not be worth it. Expert opinions vary, but most recommend that the rate of your refinanced mortgage be at least two percent lower than your current. When refinancing, you’ll still be subject to the vast number of fees and charges that come with any mortgage.

To switch types of mortgage. If your mortgage is of the adjustable-rate variety, you might have been drawn in by a low-interest rate at the beginning of the loan. But if you’re looking for more stability when it comes to your debt, switching to a fixed-rate mortgage can be very appealing. Not to mention, your fixed-rate mortgage will be immune to rising increase rates, too. Learn more about the basics of home loans and mortgages here.

If you currently have a fixed-rate mortgage and are planning on selling your home in the near future, refinancing to an adjustable-rate mortgage (ARM), which typically has lower interest rates, could be for you.

To consolidate your debt. If you’ve got high-interest credit card debt, you can use the equity you’ve built up in your home to pay it off. That way, you’re shifting that debt into a lower-interest home loan through a process commonly called “cash-out” refinancing.

This is a great option for those in good financial shape who still have high-interest debt still on their books. Since mortgage interest is usually tax deductible, consolidating that debt into a refinanced mortgage can save you on your tax bill, too. Be sure to talk to your accountant/tax adviser and mortgage lender for more specific details.

To fund home improvement projects. The same “cash-out refinancing” process that’s commonly used to consolidate high-interest debt can also be used to fund home improvement projects. Whether you’re redoing your kitchen, finishing your basement or adding a bathroom to your home, ask your mortgage lender how refinancing your mortgage and using your built-up equity can help fund it.

How Does Mortgage Refinancing Work?

How does it work, you ask? When you refinance your mortgage, all you’re doing is taking out a new loan with better terms (a better interest rate, a shorter length or both), paying off your old mortgage and starting payments on your new loan.

Here’s how you can get started on refinancing your mortgage and putting yourself in better financial condition:

Check your credit score. Making sure your credit score is in good shape is a necessary first step in deciding to pursue a refinanced mortgage. And if you’ve been good about paying your bills on time, paying down debt and staying below your credit card limits since you first took out your mortgage, there’s a good chance your credit score has improved, putting you in good position for refinancing.

Figure out your home’s current value. If your home’s value has risen in the recent past due to improvements, a strong housing market or other reasons, you could be in better position to refinance. Plenty of websites offer estimates of your home’s current value, but talk to your mortgage company or an appraiser about getting your home appraised.

Shop around for the best rate. Have a list of lenders you plan on shopping with — when you apply for a loan, the bank will pull your credit report. And when multiple agencies are repeatedly pulling your credit, your score could get lowered if it’s done over a long period of time. But by planning out your potential lenders, you can make sure their credit pulls don’t damage your score.

Plus, it’s better to have a plan versus scrambling around for the best rate. Do your research, take advantage of lenders’ online refinancing tools and ask friends and family if they’ve refinanced recently.

Get all your documents together. Once you think you’ve found the right rate and the right lender to refinance, get your documents in order. You’ll need the same things you needed to get your first mortgage: your most recent pay stubs, tax returns, bank statements and the like will be required here, too. Your lender can tell you more specifically what you’ll need, but it doesn’t hurt to be prepared.

Do the math, then make it happen. Walk through all the costs that come with refinancing with your loan officer and/or accountant to make sure refinancing makes sense. Once you’ve determined that it’ll put your current and/or future finances in better shape, make it happen. Congratulations!

Need more help protecting your most important investment? Ask your American Family Insurance agent (Opens in a new tab) about homeowners insurance and the wide variety of add-on coverages you can use to get the peace of mind you deserve.