Refinancing

Replacing an existing loan with a new one, usually to get a lower rate, change the term or switch between fixed and adjustable.

What it means

Refinancing pays off the current mortgage with a new loan. A rate-and-term refinance changes the interest rate, the length or both, while a cash-out refinance also lets the owner borrow against equity. The new loan requires an application, credit check, often an appraisal, and new closing costs.

The main test is whether the savings outweigh the costs within the time the borrower expects to keep the loan. Resetting to a fresh 30-year term can lower the payment but may raise lifetime interest, so comparing total cost, not just the monthly figure, matters.

Formula

Break-even months = closing costs ÷ monthly savings

closing costs = total cost of the new loan
monthly savings = old payment − new payment

Example

Suppose a borrower refinances a $250,000 balance from an illustrative 7% to 6%, both on 30-year terms. The payment drops from about $1,663.26 to $1,498.88, saving about $164.38 a month, so $6,000 in closing costs breaks even in about 37 months.

How it’s used

Lowering a rate after market rates fall
Shortening a term to pay off sooner
Moving from an ARM to a fixed rate
Removing a co-borrower or FHA mortgage insurance

Strengths and weaknesses

Strengths

Can lower payment or total interest
Can lock in stability by switching to a fixed rate
Can shorten the payoff timeline

Weaknesses

New closing costs
Restarting a long term can increase lifetime interest
Requires qualifying again on credit, income and equity

Educational information only, not financial, tax or legal advice. Rules, limits and rates change; check the IRS, your lender or plan, or a qualified professional before acting.