Refinancing refers to the process of a consumer applying for a secured loan that is intended to replace an existing loan, secured by the same assets. The most common form of refinancing, and the case in point considered here, is a home mortgage.

Why would a person need to apply for another mortgage to replace an existing mortgage? This may be done to reduce interest costs if one institution offers a lower mortgage interest rate than the first one. Another reason may be that the borrower wishes to reduce the risk of an adjustable rate mortgage by switching to a fixed rate loan with another lender. Other reasons could include the need to pay off additional debts, reduce one's periodic payments, or to liquidate some or all of the equity that has accumulated in real property during ownership.

The obvious advantage of refinancing is that borrowers can lower their monthly payments by either changing to a lower interest rate or by extending the period of the loan, spreading the principal out over a longer term. The money that could be saved from lower rates could be put towards paying off the principal of the balance. A borrower may also wish to transform invisible equity into ready cash for other purposes entirely. Even if monthly payments aren't a problem, refinancing still allows consumers to lower the risk of rising interest rates. Rates on an adjustable rate mortgage can shift higher or lower than the standard amount, based on different economic factors. If paying steady rates is important to the borrower (who is understandably paranoid about interest soaring) then refinancing offers definite advantages. Comparing various types of debts helps a person to understand why refinancing works.

For example, if you are in enormous credit card debt, then you are probably paying very high monthly rates and likely just paying the interest every month, if you're sending slightly over the minimum payment due amount. Credit cards are usually very high interest, especially when compared to a fixed rate home mortgage, that favors long-term payment plans. Credit card companies want their money right away and thus charge you for making them wait. Last but not least, home mortgage debt is potentially tax deductible, which is another way to save money every year. Credit card companies, car-loan debts and all these other types of plans are not tax deductible and are actually designed for short term pay offs.

However, every plan has its pros and cons. Refinancing loans do carry some amount of risk. Certain types of loans have penalty clauses if they are paid off early or even if just a specified portion is paid. Penalty clauses are instituted to protect the lender from losing the interest money that would otherwise be paid if the consumer continued paying off the loan as agreed. Some institutions not only have penalty fees but also charge closing fees and transaction fees which may be high enough to outweigh any potential savings than refinancing could bring a household. Another risk may be that some refinanced loans could offer low initial payments but then charge higher interest rates over the loan term and end up costing more than the existing loan.

Refinancing requires a very careful calculation of all costs involved in the program, including up front fees, ongoing costs and any variable costs of refinancing the loan. The only reason to consider refinancing is if a significant amount of money can be saved from doing so, whether short-term or long-term, or if there is a strong need to extend the loan to pay off major debts. Some plans may offer "No Closing" refinance, which reduces upfront fees, while others may offer "Cash Out" refinance, which basically gives you access to more cash beyond your current program, with comparable or greater monthly payments.

While refinancing may sound like a great idea, unless you can actually compare and calculate the difference (finding a significant source of savings, minus any additional transaction fees), it may amount to little more than pointlessly transferring your balance. Worse yet, you could end up taking on more financial responsibility that you can afford. Nevertheless, for many consumers who have done the math and read their contract, refinancing is the only logical thing to do.