Loan refinancing refers to the process of obtaining a new loan to pay off one or more outstanding loans. Borrowers often refinance to receive lower interest rates or otherwise reduce the amount of their repayment. Refinancing your mortgage replaces your old mortgage with a new one, one with a different principal amount and interest rate. The lender cancels the old mortgage with the new one, and then there's only one mortgage left, usually one with more favorable terms (lower interest rate) than the old one.
When you refinance, it means that you're basically taking out a new loan for your property, often for the rest you owe (but not always). Ideally, this new loan should have better terms than the previous loan. This depends on several factors, such as current mortgage rates, the amount of equity you have in your home (that is, how much of the loan you have already paid off) and what your credit rating is when you apply. When you refinance your mortgage, your bank or lender cancels your old mortgage with the new one; this is the reason for the term refinancing. The truth about mortgages states that it's important to make sure you break even before deciding to refinance the current mortgage rate.
Refinancing will hurt your credit score, as a credit check is done when you refinance your mortgage; however, this is temporary and your score will be adjusted over time. For homeowners, refinancing is a great way to lower the cost of their mortgages when interest rates drop, allowing them to get a lower interest rate than the one they currently have. With so many financing and credit options available to homeowners, refinancing a mortgage loan can seem confusing when starting the process. Basically, this occurs when refinancing costs are “recovered” through the lowest monthly mortgage payment.
Finally, even if only temporary, refinancing your mortgage could have a negative impact on your credit rating, as the lender will conduct extensive research to assess your creditworthiness. Consumer loans that are normally considered for refinancing include mortgage loans, auto loans, and loans for students.