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When you refinance your home, you seek to replace your current mortgage loan with a new loan that has more favorable loan terms. Usually, you refinance to pay off a higher-interest loan with a loan that has a lower interest rate.

However, you may also decide to refinance to replace a fixed-rate mortgage loan with an adjustable-rate loan, or vice versa. After you refinance, the new lender holds a mortgage lien on your home.

When you refinance, you can choose to borrow just enough to pay off the mortgage balance you owe. If you have enough home equity built up, you may also be able to borrow an additional amount in what is called a "cash-out" refinancing. You can use this extra amount to pay off other debts such as an auto loan or credit cards. You should evaluate a cash-out refinancing carefully.

If you're thinking of refinancing your current loan balance, see:

Am I better off refinancing?

Before you refinance just to cut your rate a half-percentage point or so, be sure to consider all the costs of refinancing, including:

Closing costs. Your closing costs include points. The IRS also calls these mortgage points, discount points or origination fees. Lenders that specialize in refinancing typically charge 1 or more points, with 1 point equal to 1% of the loan amount. Points are usually the largest closing cost. You should also expect to pay for other expenses directly related to processing and approving your application. These costs may include fees for a credit report, title search, title insurance, appraisal and recording a new mortgage lien.

Application costs. Some lenders may charge an application fee to refinance. Paying a loan application fee is something only the most desperate of loan applicants should face. If you have a good credit history, you should be able to avoid paying a loan application fee.

A loss of tax-deductible mortgage interest. When you refinance with a lower rate, you usually reduce the amount of mortgage interest you pay. As a result, you lose some future tax savings that you would otherwise have with a higher-rate loan.

To help you itemize your closing costs on a loan refinancing, see:

What will my refinancing costs be?