Refinancing is the process of securing a new loan to replace an existing home mortgage in an effort to obtain a financial advantage.

There are a variety of reasons homeowners may wish to refinance. Some who took out mortgages when interest rates were high decide to refinance to get a lower rate.

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Others see refinancing as a way to manage personal debt, lock in a lower monthly payment, exchange an adjustable-rate mortgage for a fixed-rate one whose payments are the same every month over the term of the mortgage or even to pay off their loan faster.

Freeing up cash by tapping into their home equity also allows them to finance other major projects, such as extensive and expensive renovations.

But refinancing comes at a price. Just as it is with the initial purchase of the home, origination fees, title insurance, application fees, taxes and closing costs must be paid when the new loan is taken out.

Refinancing can be a smart way to lower your monthly mortgage payments. Credit: Scott Graham/Unsplash

Depending on the amount of the new loan and its interest rate, which is determined by the homeowner’s credit score, it may not be wise or feasible to refinance because of these costs. 

The timing of the initial refinancing varies. Some mortgages allow immediate refinancings; others require a waiting period of varying length.

Although there are lenders who promise “no-cost refinancings” without closing costs, this is misleading because the lenders make up the lost income by charging a higher interest rate.

There are other factors to consider. Refinancing restarts the mortgage process and payments again, prolonging the length of the mortgage. For example, a homeowner who has paid 10 years on an existing 30-year mortgage and replaces it with a new 30-year mortgage will end up making payments for 40 years, which will cost more in the long run.

And homeowners who have been making payments for decades may save more by simply making higher or additional payments on their current mortgage to pay it off more quickly.

The longer the homeowner has been making mortgage payments, the less financial advantage there is to securing a new loan unless a shorter-term loan replaces the first. And even then, the numbers may not work out.

Homeowners who are considering refinancing are advised to consult their lenders and also to get an idea of their savings by using free online mortgage-estimate calculators.

In general, it is considered wise to refinance only if the new interest rate allows the homeowner to recover the refinancing costs within two years of taking out the new loan. And refinancing makes sense only when the new mortgage interest rate is at least a full percentage point less than that of the previous loan.

Typically, refinancing will cost 2% to 6% of the amount borrowed, but that often depends on the geographical location of the home.

Interest rates aside, there are many other factors that determine whether refinancing is financially worthwhile. Those who plan to sell their homes in only five or seven years may find that the numbers don’t work in their favor.

Multiple or serial refinancings on the same property to secure a lower interest rate in response to market shifts are not considered cost effective because of the expenses associated with taking out the new loan.