Refinancing Loans: What It Means and When To Do It 

Written by:

Baylor Cox

Reviewed by:

• Jean Hopkins

Refinancing a loan can be a powerful way to improve your financial situation. When you refinance, you replace your current loan with a new loan that has better terms. The goal is to lower your monthly payments, reduce your interest rate, shorten your loan term, or change your loan type such as switching from an adjustable rate to a fixed rate. 

By getting a new loan, you can potentially save thousands of dollars over the life of your loan. But refinancing also comes with costs, so it is important to understand how it works before deciding. 

How Does Loan Refinancing Work? 

When you refinance, you take out a new loan to immediately pay off your old loan. After that, you only make payments on the new loan. 

You might qualify for better loan terms because: 

• Interest rates have dropped since you got your original loan 

• Your credit score has improved, making you eligible for lower rates 

• You want to change your loan term (shorter or longer) 

• You want to switch from a variable interest rate to a fixed one for stability 

Example: If you refinance a 30-year mortgage to a 15-year mortgage with a lower interest rate, you could pay off your home faster and save on total interest costs. 

What Are the Costs of Refinancing? 

Refinancing is not free. Lender’s charge closing costs, which usually range from 2% to 6% of the loan’s remaining balance. 

• On a $300,000 mortgage, that is $6,000 to $18,000 in refinancing costs. 

• You might be able to roll these costs into the new loan, but that increases your loan balance and total interest. 

Because of these costs, you should only refinance if the savings outweigh the fees. A good rule of thumb is to calculate your break-even point: how long it will take for your monthly savings to add up to the cost of refinancing. 

Example: 

• Current payment: $1,000/month 

• New payment: $600/month 

• Monthly savings: $400 

• Refinance costs: $3,000 

• Break-even time: $3,000 ÷ $400 = 7.5 months 

If you plan to keep the loan longer than 7.5 months, refinancing could be worth it. 

Types of Loans You Can Refinance 

You can refinance several kinds of loans. The most common include: 

Mortgage Refinancing 

Mortgage refinancing is the most common type of refinancing. Many homeowners refinance to get a lower interest rate or to shorten their loan term. 

• How does refinancing a mortgage work? 

• You apply for a new mortgage with better terms and use it to pay off your old mortgage. Then you start making payments on the new mortgage. 

• Why refinance a mortgage? 

• Lower your interest rate 

• Shorten your loan term to pay off your home faster 

• Lower your monthly payments by extending your loan term (though this increases total interest paid) 

• How much does refinancing a mortgage cost? 

• Typically, 2% to 6% of your loan amount. Be sure to ask your lender for an estimate of closing costs before moving forward. 

Auto Loan Refinancing 

Auto refinancing can help you lower your car payments or interest rate. If interest rates have dropped or your credit score has improved, you may qualify for a lower rate, which can save you money each month and over the life of your auto loan. 

Student Loan Refinancing 

You can refinance student loans by taking out a private loan to pay off existing federal or private student loans. 

Important: If you refinance a federal student loan with a private loan, you lose access to federal benefits like income-driven repayment plans, deferment, forbearance, and loan forgiveness programs. Be sure the savings outweigh what you would give up. 

Debt Consolidation 

You can also refinance by consolidating multiple smaller debts, like credit card balances, into a single personal loan. This can give you: 

• One predictable monthly payment 

• A potentially lower interest rate 

• A set payoff timeline instead of revolving debt 

When Is It Worth Refinancing? 

Refinancing can be worth it when: 

• Interest rates are lower than when you got your original loan 

• Your credit score has improved 

• You want to change the length of your loan term 

• You plan to keep the loan long enough to reach your break-even point 

Before refinancing, take these steps: 

1. Find your refinancing costs – Ask lenders for a cost estimate, including closing fees. 

2. Calculate your monthly savings – Compare your current payment to your potential new payment. 

3. Determine your break-even point – Divide the total refinance cost by your monthly savings. 

4. Consider your timeline – If you plan to keep the loan beyond your break-even point, refinancing may save you money overall. 

Key Takeaways 

• Refinancing replaces your current loan with a new one that has better terms. 

• You can refinance mortgages, auto loans, student loans, and personal loans. 

• Mortgage refinancing is the most common and can save thousands in interest. 

• Refinancing typically costs 2%–6% of your loan balance, so calculate your break-even point first. 

• Refinancing can lower payments, reduce interest, or shorten your loan term—but only if the savings outweigh the costs.