What Actually Happens When You Refinance a Mortgage?

Refinancing can sound more complicated than it really is.

At its core, you are replacing your existing mortgage with a new mortgage.

The new loan pays off the old loan, and from that point forward you make payments according to the terms of the new loan.

The interesting part isn't the process.

It's deciding whether the new structure actually improves your financial position.

Your old mortgage gets paid off

Suppose your current mortgage balance is $325,000.

When you refinance, the new lender obtains a payoff statement showing exactly what is required to satisfy the existing mortgage.

Your new loan then pays that mortgage off as part of the refinance closing.

You don't keep two mortgages.

One replaces the other.

What happens to your interest rate?

Your new mortgage is based on the interest rate and terms available when you refinance.

That could mean:

• lowering your rate
• changing from an adjustable-rate mortgage to fixed
• changing your loan term
• accessing equity
• removing or changing mortgage insurance
• restructuring debt

A refinance isn't automatically worthwhile simply because the new interest rate is lower.

Refinancing costs money

There may be lender costs, title costs, recording charges, appraisal fees and other closing expenses.

Those costs can sometimes be paid out of pocket, financed into the new mortgage, or offset in other ways depending on the loan structure.

This is where the break-even point becomes important.

Suppose refinancing costs $4,000 and reduces your payment by $200 per month.

A simple payment-based break-even calculation would be:

$4,000 ÷ $200 = 20 months

If you expect to keep the mortgage much longer than that, the refinance may become increasingly beneficial.

If you're selling the house six months later, the math is very different.

What happens to escrow?

If your current mortgage has an escrow account for taxes and insurance, that escrow account belongs to the existing loan.

When the old mortgage is paid off, any remaining eligible escrow balance is generally handled separately by the old servicer.

Your new lender may establish a new escrow account.

This can temporarily make the amount of cash moving around during a refinance look confusing, even though those funds are serving different purposes.

Does refinancing mean you "skip" a mortgage payment?

You'll often hear someone say they skipped one or two mortgage payments after refinancing.

That's not quite what happens.

Mortgage interest is accounted for through the timing of the payoff, prepaid interest and the first payment date on the new mortgage.

There may be a period where you aren't physically making your normal monthly payment, but the interest didn't disappear.

The goal isn't refinancing. The goal is improving your position.

A refinance should solve something.

Maybe it lowers your payment.

Maybe it accelerates payoff.

Maybe it allows you to consolidate expensive debt.

Maybe it improves cash flow.

Maybe it accesses equity for something important.

Before refinancing, ask:

What does this accomplish, what does it cost, and how long will it take for the benefit to outweigh that cost?

That's the calculation that matters.

— Nathan Williams