What it Means to Refinance Your Mortgage
Learn all about mortgage refinancing - what it is, how it works, and why it may be worth a look
Updated 
10 min. read
You're living the American dream with a beautiful home, complete with a picket fence and a mortgage. However, you might be looking for ways to trim monthly payments if interest rates have changed, recently.
You’ve heard that refinancing your mortgage might help with that. But what is it, and can it make your life easier?
What is mortgage refinancing?
Simply put, refinancing is the process of replacing your old loan with a new one to gain a more favorable rate or term, or to access money based on your home’s available equity.
Refinancing your mortgage - or “refi” for short - is something you might consider to get better terms on your mortgage. It can be tempting to dive in when there are significant changes in the interest-rate landscape. Take a moment to learn more about how it works, first.
Types of refinancing
There are various types of refinancing, each with unique features and benefits. It's important to consider your financial situation when deciding which one is right for you. But let's take a quick look at the two most popular options: rate-and-term refinancing and cash-out refinancing.
Rate-and-term refinancing is the most common type of refinancing. It is the process by which your original loan is replaced by another mortgage with new principal and interest payments, and possibly new terms.
Cash-out refinancing lets you turn a portion of your home equity into cash by refinancing your mortgage. While you can’t cash out all of your home equity, it does give you access to a larger sum of money without the need to sell.
Keep in mind that refinancing your mortgage replaces your existing mortgage with a new one. That means that important factors could change, including the loan term and the interest rate.
Now let’s take a closer look at how cash-out refinancing compares to a home equity line of credit.
Cash-out refinancing vs a HELOC
How does cash-out refinancing differ from a home equity line of credit (also called a HELOC)? Both tools give homeowners access to funds in exchange for equity in their homes, but they function differently.
As we’ve covered above, cash-out refinancing works by allowing you to access the equity in your home by refinancing your mortgage at a larger amount. If you have available equity, you can receive a lump sum of funds at closing.
A home equity line of credit, on the other hand, is a revolving line of credit secured by your home, that allows you to borrow and repay funds, as needed during the draw period.
During the draw period, which typically lasts around 10 years, you can borrow as much or as little as you need, up to the credit limit you established when you got the HELOC. And the best part? As you repay the outstanding balance, the credit becomes available to you again. At the end of the draw period, usually, a 20-year repayment period begins, where you'll be repaying what you borrowed.
When it comes to interest rates, HELOCs come with options. You can choose between fixed rates and variable rates, so you have flexibility in how you want to manage your borrowing costs.
The following chart offers a detailed breakdown of the distinctions.
| Criteria | Cash-out Refinancing | HELOC |
|---|---|---|
| How it works | Replaces current mortgage and offers cash payment based on available equity in your home | Line of credit based on equity in your home |
| How you receive funds | Paid in a lump sum | Balances are drawn during draw period |
| Interest rates | Fixed or variable interest rate | Fixed or variable interest rate |
| Monthly payments | Mortgage payment based on scheduling preference | Additional monthly payment |
When does it make sense to refinance your mortgage?
Though not for everyone, refinancing can prove beneficial in many situations. Consider the following advantages:
Advantages of refinancing
Reduce your interest rate. You may be able to lock in a lower interest rate during favorable market conditions, which can lead to smaller monthly payments. Factors such as a strong credit score and a change in market can also play a role in this financial strategy.
Let’s look at an example: Jane wants to refinance her mortgage after five years. She bought a $400,000 home on a 30-year term with a down payment of $80,000 at a 6.50% interest rate. That means her mortgage loan is $320,000, and her monthly payment is $2,023. If she refinances when interest rates are lower (down to 4.50% after five years in this case), then she can lower her monthly payment to $1,516.
This lets Jane save $507 per month by refinancing her mortgage during favorable market conditions.
| Previous | Refinanced | Savings | |
|---|---|---|---|
| Mortgage amount | $320,000 | $299,555 | Approx. $60,376 in total interest |
| Interest rate | 6.5% | 4.5% | 2% |
| Monthly payment | $2,023 | $1,516 | $507 |
Explore your savings opportunities with our mortgage refinancing savings calculator.
Shorten your term. By changing your mortgage repayment plan, say from a 20-year to a 15-year term, refinancing allows you to pay off your loan quicker while reducing the amount of interest owed. While your monthly payments may increase, you’ll pay off your mortgage sooner.
Change your type of loan. Maybe an adjustable-rate mortgage was suitable when you purchased your home, but now you may prefer the stability of a fixed rate. Refinancing could help you achieve that.
Use equity to borrow money. Cash-out refinancing makes it possible to access much-needed funds to cover significant expenses like home improvement projects, debt consolidation or putting your child through college. Leveraging the equity you’ve accumulated in your home may add more debt to your tally, but it can help you secure money at a lower interest rate than other types of loans would allow.
Things to keep in mind when refinancing
Every big financial step requires careful consideration. While the pros of refinancing are many, potential downsides exist too.
For one thing, refinancing may result in an extended loan term, increasing your loan balance and delaying your payoff date. Additionally, when you refinance your mortgage, there may be other costs to think about, like appraisal fees and your mortgage lender’s closing costs. It's important to factor in these closing costs when evaluating the overall benefits of refinancing.
Then there’s the possibility that interest rates may drop after you close, or that your monthly payments might increase. Your credit score might also be affected temporarily.
Steps to refinance a mortgage
How do you get started with mortgage refinancing? We've got you covered with a step-by-step guide that breaks it all down into simple and actionable tasks.
Step 1: Determine your short- and long-term goals
No one should pursue refinancing without knowing why. Is it to reduce your monthly payments, or to lock in a lower interest rate? Do you want to shorten your loan term? Does your home require significant repairs? Not only will answering the “why” help direct you to the right refinancing option, but it will keep you on track to get the best outcomes, too.
Step 2: Assess your current mortgage and financial situation
Before diving into refinancing your mortgage, let's check the essentials of your current loan:
- Your current rate
- Your term
- Your outstanding balance
As a tip, lenders usually prefer borrowers to have 20% equity in their home before applying for refinancing.
As with any loan, a good credit score and credit history are prerequisites for refinancing. Your finances will be assessed to determine risk and eligibility.
Take a moment to check your debt-to-income ratio (your total debt payments compared to your gross income) and overall financial stability before jumping into refinancing. Typically, your debt-to-income ratio should be lower than 50% to qualify for a loan.
Lenders need to feel confident that you can repay the loan. You should feel confident about it, too.
Step 3: Examine the costs associated with refinancing
Refinancing can prove financially advantageous, but remember to account for other potential costs related to it. Depending on your lender, you may be responsible for covering things such as certain taxes, closing costs, and appraisal fees. Check with your lender and put together an estimate of these costs to make sure you’ll still come out ahead before proceeding.
For help estimating the costs and potential savings you’ll see through refinancing, try BMO’s Mortgage Refinancing Savings Calculator.
Step 4: Compare multiple mortgage lenders
As the saying goes, shop around before making a commitment. Here’s what we advise:
- Get quotes from various mortgage lenders.
- Compare their interest rates, payment options and loan terms.
- Ask about their costs for refinancing (this can vary by lender).
- Confirm if your loan fees will be rolled into your new mortgage or if they’re paid in advance.
Additionally, it's worthwhile to review term lengths to explore alternative options that align with your repayment capabilities. The most common terms you can choose are 5, 7, 10, 15, 20, and 30 years.
Asking the right questions and doing some comparison shopping will help you find your ideal rate. Don’t forget to lock in your rate with the chosen lender before the refinance closes.
Step 5: Get your paperwork in order and apply
Make sure to gather the necessary documentation ahead of time. That would include things like these:
- Pay stubs
- Tax returns
- Bank statements
- Proof of home ownership
- Insurance policy documents
- Records of assets and liabilities
There’s also your credit score to consider. It’s one of the most important pieces of information that the lender considers, but they need to make an independent inquiry for it. You can get a free credit report to see your score before applying.
Time frame of a mortgage refinancing process
The timeline to complete a refinance may vary by lender and borrower, but typically it can take between 45 and 60 days. Several factors can affect that time frame. For example: if you leave the country and don’t provide documentation, it could increase the timeline.
The underwriting process, appraisals, inspections and financial paperwork can all affect that timeline, which is why it helps to have your documents ready as soon as you decide to start the process.
We’d also recommend being prepared for a home appraisal just in case the lender requires one to be completed. This might involve a third-party appraiser doing a walkthrough around or inside your home, but these can be completed within an hour in most cases.
Final Takeaways
Refinancing can be a valuable tool for homeowners. It can help you make real financial progress by reducing the interest rate on your mortgage (leading to more savings) or by accessing money through your home’s available equity.
If you’re looking to refinance your mortgage, the BMO refinancing calculator is a handy tool that can estimate your potential savings. It can also help you clarify related expenses so that you can figure out if this is the right next step for you.
Mortgage Refinancing FAQs
While lenders don’t tend to limit the number of times you can refinance your mortgage in general, your loan agreement may limit how often you can refinance within a given time frame.
It can cost anywhere between 2% and 5% of the amount on a fixed rate mortgage.
It’s possible for your credit score to dip after refinancing, but only temporarily. The good news is your credit score will rebound so long as you continue making your payments on time.
Yes, if lower interest rates are available to you. By taking out a new mortgage on your home that replaces your current one, you could get a lower interest rate. Having a lower interest rate can decrease your monthly payments. This is one of the most common reasons to refinance a mortgage.
No, a second mortgage is not the same as refinancing. With a second mortgage, you take out an additional mortgage on a property that already has an existing first mortgage, while a refinance replaces the existing first mortgage with a new first mortgage.
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