How Mortgage Refinancing Works, Step by Step

A refinance replaces your mortgage with a new one, usually to get a lower rate, a different term, or cash out of your equity. The process looks like the original purchase loan without the house hunting, and it takes 30 to 45 days from application to funding. This guide explains how mortgage refinancing works at each step, what it costs, and where borrowers lose money. Before you start, run the numbers in the refinance calculator; the example below is a $350,000 balance at 7.25% with 25 years left, refinanced to 6.25% for $9,000 of closing costs.

The three kinds of refinance

A rate-and-term refinance changes the rate, the term, or both, and the new loan amount is the old balance plus any costs you roll in. It is the one most people mean.

A cash-out refinance borrows more than you owe and gives you the difference in cash at closing, usually capped at 80% of the home’s appraised value. The rate is a little higher than rate-and-term, and the new rate applies to the whole loan rather than to the extra cash alone.

A streamline refinance, available on FHA, VA and USDA loans, skips the appraisal and most of the income documentation if you are refinancing the same type of loan to a lower rate. It is faster and cheaper but limited to those programs.

Step 1: decide whether it pays

The refinance only helps if the monthly saving recovers the closing costs before you sell or refinance again. On the example loan the payment falls from $2,530 to $2,309, a saving of $221 a month. Divided into $9,000 of costs, the break-even is 41 months. Stay past that and the refinance is ahead; sell before it and you lost money. Over the full 25 years the saving is $66,294 before costs.

Keep the remaining term when you compare. Writing the new loan as a fresh 30-year drops the payment to $2,155, which looks better, but adds five years and leaves you paying $425,804 of interest against $342,653 on a 25-year term at the same rate. The refinance calculator uses the remaining term for this reason; ask the lender to price a 25- or 20-year term, which most will do.

Step 2: shop the rate

Get loan estimates from at least three lenders within a two-week window, so the credit inquiries count as one. The loan estimate is a standard three-page form; compare the rate, the APR, the “total closing costs” line and the “cash to close” line, and look at section A for the lender’s own fees, which vary the most. Credit unions and mortgage brokers often beat the bank you already use.

Points are prepaid interest: one point is 1% of the loan and typically lowers the rate by about a quarter percent. They only pay if you keep the loan well past the break-even, so on a refinance you might do again in three years, skip them.

Step 3: apply and lock

The application is the same uniform form as a purchase. You will provide two years of W-2s or tax returns, recent pay stubs, two months of bank statements, the current mortgage statement, the homeowners insurance declaration and photo ID. Self-employed borrowers add profit-and-loss statements and business returns.

Once approved in principle, lock the rate. A lock holds the rate for 30, 45 or 60 days while the loan closes; longer locks cost a little more. If rates fall after you lock, some lenders offer a float-down for a fee. If the lock expires because the appraisal or title work ran late, extending it costs money, so pick a period that fits the lender’s actual turnaround.

Step 4: appraisal and underwriting

The lender orders an appraisal, $400 to $700, to confirm the home is worth enough for the loan-to-value the program requires. A low appraisal can turn a rate-and-term refinance into one that needs PMI, or cut the cash available on a cash-out. Some conventional refinances qualify for an appraisal waiver through the automated underwriting system, which saves both the fee and a week.

Underwriting checks income, assets, credit and the title. Expect requests for letters of explanation on large deposits, credit inquiries or employment gaps. Answer them the same day; most delays in a refinance are documents sitting in an inbox. Do not open new credit, change jobs or move large sums between accounts while the file is in underwriting; each one triggers a new round of questions, and a new car loan can push the debt-to-income ratio past the limit the loan was approved at.

Step 5: closing disclosure and closing

Three business days before closing you receive the closing disclosure, a five-page form that must match the loan estimate within set tolerances. Check the rate, the term, the closing costs and the payoff amount of the old loan against your latest statement; the payoff includes interest to the closing date, so it is a little higher than the balance.

At closing you sign the new note and mortgage. For a refinance on your primary home, federal law gives you three business days to cancel after signing; the loan funds on the fourth day. The new lender pays off the old one, and you usually skip a payment because interest is collected at closing for the rest of that month and the first payment on the new loan is due the month after next.

What the closing costs are

Prepaid interest and the new escrow account are not costs in the sense of money lost; the old escrow balance is refunded to you after payoff, and the interest would have been paid anyway. The costs that matter for the break-even are the lender, title, appraisal and recording fees, which is what the calculator asks for.

Where borrowers lose money

Resetting to 30 years without noticing. Rolling costs into the loan and then paying interest on them for decades. Taking a no-closing-cost refinance at a higher rate when they will keep the loan a long time: on the example, 6.625% instead of 6.25% saves $139 a month instead of $221 and costs $25,000 more over the term. Refinancing a loan with only ten years left: $150,000 at 7.25% refinanced to 6.25% saves $77 a month, and $9,000 of costs takes 118 months to recover, nearly the whole term.

Before you apply

Check your credit score and fix errors; a score above 740 gets the best pricing. Check how much you can borrow against the new payment with the how much can I borrow calculator, since the refinance has to pass the same debt-to-income test as a purchase. Then run the refinance calculator with each loan estimate’s rate and costs, and the loan payment calculator to see the payment on a shorter term. All the tools are on the homepage.

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