Refinancing a Loan Could Save You Money - Here's How

You may have heard about refinancing a loan, but you’re not quite sure what it means or how the process works. If you have a current loan, you can refinance to replace your existing loan with a new loan that offers better terms and/or features.

Refinancing a loan is often an excellent choice. It may help you save money or better manage your debt if you can find a new loan with more favorable terms. Refinancing typically is not overly complicated or time-consuming, but it may not be right for every situation.

As we show you the ins and outs of refinancing a loan and whether you should consider it, keep track of any mortgage questions to ask your lender for later.

What is refinancing a loan?

Refinancing may sound like a complex financial term, but it can be relatively simple to understand. When you refinance a loan, you pay off an existing loan with a new loan. It may seem like that wouldn’t accomplish much (because you’d still be in debt), but taking out a new loan could offer you many benefits.

Refinancing a loan can come in handy if you’re struggling to pay off debt and can’t keep up with your current loan payments. You can refinance your loan to update the term agreement, which could result in a longer loan term and lower monthly payments. Or, you can refinance to receive lower interest rates and reduce the overall cost of what you owe on the loan.

You can refinance almost any debt, although refinancing a mortgage loan is one of the most common practices. Refinancing your mortgage is a way to pay off your current mortgage loan with a new mortgage loan that offers better terms. If you’re seeking a better interest rate or looking to pay off your mortgage faster, it may make sense to consider a refinance.

How do you refinance a mortgage loan?

Refinancing a mortgage loan should be a process that you approach with care and consideration. The process of how to get a loan is very similar to how you took out your existing mortgage, so you can expect certain eligibility requirements and possible closing fees. Here are some important things to consider.

Waiting period

If you’ve recently taken out a mortgage loan, you may need to wait before you can refinance. Each situation is different, but loans often have waiting periods of six to 12 months before you can refinance. In other cases, you may be able to refinance immediately.

Rate shopping and credit score

To begin, it’s essential you research the best mortgage lenders so that you get the best possible deal for your financial needs. Getting quotes from multiple lenders (including your current lender) can help you compare rates and find the best offer. Talking with your current lender after you’ve checked competitor rates might help you get better terms and stay with them.

Shopping around for different rates won’t affect your credit score until you actually apply for a loan, but you should make sure your credit is healthy and won’t take any hits as you go through the refinancing process. The higher your credit when you apply for a loan, the more likely you’ll get favorable terms.

When you apply to refinance a loan, your credit report will be hit with a hard credit pull. This is simply a check on your creditworthiness that helps the lender determine the terms it can give you for a loan. If you’re rate shopping, make sure you apply for loans from different lenders within a short time frame so the credit bureau can count all the similar hard pulls as one. This will greatly diminish the possible negative impact of a hard pull on your credit score.

Even if your credit is reduced by a small amount from a loan application, making your loan payments on time and in full can help improve your credit score fast.

Application and documentation

You may remember this process from your original loan application, so it shouldn’t be a surprise that banks and lenders will require you to do the same thing when you refinance a loan. Here are some common items, documents, and information you may need when applying to refinance a loan:

• Full legal name, Social Security number, and birthdate
• Government-issued photo ID
• The total value of all assets, including statements from bank and investment accounts
• The total value of all expenses, including statements from any loans or debt
• Proof of income (pay stubs and/or federal income tax returns if self-employed)
• Past employment and income history (W-2s, tax returns, and/or 1099s)
• Homeowners insurance policy
• Title insurance documentation

You can make the loan process quicker and easier if you gather these documents and information together before applying for loan refinancing.

Time frame

Refinancing a mortgage loan can take some time, so don’t expect to be done with the process in a few days or less. On average, a typical mortgage loan refinance can take between 30 to 45 days, but there’s no guaranteed time frame. The process may go quicker or slower depending on appraiser availability, the readiness of required documents, and other factors.

Closing costs and other fees

As you go through the process of refinancing a mortgage loan, make sure you take note of any fees or costs along the way. Some lenders charge certain fees, such as application or appraisal fees, and others don’t. You can generally expect to pay closing costs, which are often 2% to 6% of the total loan balance.

What are the benefits of refinancing your mortgage?

The only reason to refinance your mortgage is to get a new home loan with better terms than your existing loan. When you refinance a mortgage loan, you may have one of a few different goals in mind:

• Reduce your monthly payment amounts: If you find you can’t keep up with the amount you’re paying each month on your current mortgage, it would make sense to consider refinancing your existing loan. To reduce your monthly payments, you would typically have to increase the term (length) on your new loan.
• Reduce the interest rate of your loan: To reduce the interest rate, you would likely need to reduce your loan term and increase your monthly mortgage payments. You’ll pay less interest over time with a shorter-term loan.
• Moved from an adjustable-rate to a fixed-rate mortgage: If you have an adjustable-rate mortgage, you may choose to refinance to a fixed-rate for more predictability or a lower rate over the life of the loan.
  
• Use equity to cover expenses: If you have equity in your home — the difference between the appraised value of your home and the remaining balance on your mortgage — you can use a cash-out refinance to get needed money for large purchases and expenses. For example, a cash-out refinance may help you cover the costs of purchasing a new vehicle, paying for college tuition, paying down credit card debt, or making valuable home improvement investments to your property.

The goals may be different, but they can all be achieved through loan refinancing.

What are the downsides of refinancing your mortgage?

Many financial decisions can come with risk attached, and refinancing your home mortgage is no exception. Here are a few possible downsides to mortgage refinancing:

• Fees and costs: You won’t get through the refinancing process without paying some fees and/or closing costs. Remember to calculate your break-even point — the point at which your savings outweigh the fees and costs — before applying for a new mortgage loan. In some cases, refinancing may not make sense financially if the fees and costs are too high.
• Recouping costs: Your refinancing savings need to be high enough in order to recoup the amount you pay for fees and closing costs. For a simple analysis, let’s say refinancing fees and costs total $5,000. With the new loan, you end up saving $125 each month, so your break-even point would be 40 months ($5,000 divided by $125). From that point forward, you’re saving money. If you aren’t planning on staying in your home long enough to recoup your refinance costs, it may not make sense to refinance your mortgage.
• Higher monthly payments: If you’re looking to reduce your accrued interest, the best way with refinancing is to decrease the length of your loan. The total amount of interest costs will decrease, but your monthly payments will rise because you have to pay off your balance in a shorter amount of time.
• More accrued interest: If you’re struggling to keep up with your monthly payments, you may opt to refinance your mortgage to decrease the amount you pay each month. This will typically increase the length of your loan to spread the balance out over a longer period of time. In turn, you’ll end up accruing and paying more interest because it’s taking longer to pay off your debt.

FAQs about refinancing your mortgage

The bottom line on refinancing a loan

The process of refinancing a loan can yield valuable savings that can help you better manage and pay off your debt. It can also help you cover necessary expenses if you have sufficient home equity.

Remember to weigh the pros and cons as you look into refinancing a loan. It can make sense for many situations, but the savings won’t always outweigh the costs.