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If you are looking to save money, refinancing may be just what you need. Let's see how does refinancing work.

When you refinance, you simply pay off one loan with another. The reason you do this is because the new loan terms are more favorable than the previous. Even though it costs money to refinance, the main reason for refinancing is to save money (over the long term).

There are many ways you can save money by refinancing your mortgage.

- By replacing your current mortgage with a loan with a lower interest rate, you save money monthly and over the course of the loan.

- By changing the term or length of your loan, you can lower your monthly payments.

- If you have enough equity in your home, you can consolidate your all your bills into one payment and stretch the total out over the course of your loan which will in most cases drastically reduce the amount you pay monthly.

When is it worthwhile to refinance? It doesn't make sense for everyone but if you follow the rule of thumb you have a pretty good chance of saving money. If you're just looking to lower your interest rate, consider refinancing when advertised interest rates are 1.5 to 2% lower than your current rate. Because of how refinancing works, you should plan to stay in your house another 3 years to really reap the benefits of a lower interest rate.
Some other reasons to refinance include:

- Change to a fixed rate. Your adjustable rate mortgage (ARM) may soon become unmanageable. If you refinance you wont have to worry about how much your payments will be as the rates continue to adjust.

- Build up equity quicker. If you have a substantial increase in disposable income, you can reduce the term of your loan. Your payments will be higher but you'll be paying off the principal quicker.

- Do a cash out refinance. Use the equity in the home to pay for a major purchase or college education.

What Are The Costs of Refinancing

When you're asking about how does refinancing work, you have to think about the costs that go along with it. Plan on paying about 3-6% of your principal in refinancing costs, plus any prepayment penalties. In order to keep clients from refinancing often, many companies will include a prepayment penalty. Your mortgage documents will clearly state if you have a prepayment penalty - although it may not clearly state how much it is. It is up to you to determine if it is worth it to refinance with these costs. Many times the refinancing lender will roll the costs into the loan so you don't have to pay so much up front. Just be aware that you will be paying these costs, and actually more because you now have interest on top of it.