Mortgage Refinancing: How It Works and When It Makes Sense – How Does Refinancing a Mortgage Work?

I will search for current average mortgage refinance closing costs in the US and the typical credit score impact of a mortgage refinance application.

I will also perform a keyword search for “mortgage refinance calculator with closing costs” to ensure the information about tools is up-to-date.

A mortgage refinance is the process of replacing your current home loan with a new one.1 This new loan pays off the balance of your old mortgage, and you then make payments on the new mortgage based on its terms.

People typically refinance for several reasons:

To reduce their interest rate and/or monthly payments: If current mortgage rates are lower than your original rate, refinancing can lead to significant long-term savings and lower monthly outgoings.² This is often achieved through a “rate-and-term” refinance.
To tap into home equity: A “cash-out refinance” allows you to borrow more than your outstanding mortgage balance and receive the difference as cash.³ This cash can be used for various purposes like home improvements, debt consolidation, or other large purchases.⁴
To pay off the loan faster: By refinancing into a shorter loan term (e.g., from 30 years to 15 years), you can save on the total interest paid over the life of the loan, though your monthly payments will generally increase.⁵
To eliminate FHA mortgage insurance: If you have an FHA loan with mortgage insurance premiums (MIP) that will last for the entire loan term, you can refinance into a conventional loan (assuming you have at least 20% equity) to remove this ongoing cost.⁶
To switch loan types: Refinancing can allow you to convert an adjustable-rate mortgage (ARM), where interest rates can fluctuate, to a more stable fixed-rate loan.⁷

How Refinancing Works (Step-by-Step):

The refinancing process is similar to obtaining your original mortgage:

Assess Your Situation: Lenders will evaluate your credit history and score, payment history on your existing loan, income, employment history, home equity, home’s current value, and other debt obligations.⁸ A strong financial standing can lead to better new loan terms.
Shop Around: Apply for preapproval with multiple mortgage lenders to compare interest rates and terms. This helps you find the best offer. It’s recommended to get Loan Estimates from at least three lenders.
Run the Numbers: Compare the potential monthly savings from a new loan against the closing costs. Calculate your “break-even point” – the time it takes for your accumulated monthly savings to exceed the refinance closing costs. If you plan to move before reaching this point, refinancing might not be financially advantageous.
- Many online mortgage refinance calculators are available that allow you to input your current loan details, desired new terms, and estimated closing costs to calculate potential savings and your break-even point.⁹
Submit Your Application: Once you choose a lender, you’ll submit a formal application along with required documentation such as pay stubs, W-2s, bank statements, and tax returns. The application-to-closing process can take around 48 days on average.¹⁰
Close Your Loan: This involves signing paperwork and paying closing costs.¹¹ The new lender then pays off your original loan, and you begin making payments on the new mortgage.¹² If it’s a cash-out refinance, you’ll receive the cash at closing.¹³

Costs of Refinancing:

Refinancing involves closing costs, similar to a purchase mortgage.¹⁴ These typically range from 2% to 6% of your outstanding principal balance. For example, a $200,000 loan could incur $4,000 to $12,000 in fees. These costs can include:

Origination fees
Underwriting fees
Appraisal fees
Credit report fees
Attorney fees
Title fees
Government recording costs
Various service fees

Some lenders may offer “no-cost” refinances, but these often involve higher interest rates or the closing costs being rolled into the loan amount, leading to more interest paid over time.¹⁵

Impact on Credit Score:

Applying for a mortgage refinance typically results in a temporary, minimal dip in your credit score, often fewer than 5 points, due to a “hard inquiry” on your credit report.¹⁶ This inquiry can remain on your report for up to two years, but its impact on your score usually lasts for a shorter period (around one year). To minimize the impact, it’s advisable to submit all applications within a short timeframe (e.g., 14-45 days), as many credit scoring models treat multiple inquiries for the same type of loan within this window as a single inquiry. Closing your old mortgage account and opening a new one can also slightly affect the “length of credit history” factor in your score.