Refinancing a mortgage means paying off an existing loan and replacing it with a new one. There are many common reasons why homeowners refinance: the opportunity to obtain a lower interest rate; the chance to shorten the term of their mortgage; the desire to convert from an adjustable-rate mortgage (ARM) to a fixed-rate mortgage, or vice versa; the opportunity to tap a home's equity in order to finance a large purchase; and the desire to consolidate debt. Some of these motivations have both benefits and pitfalls. And because refinancing can cost between 3% and 6% of the loan's principal and - like taking out the original mortgage - requires appraisal, title search and application fees, it's important for a homeowner to determine whether his or her reason for refinancing offers true benefit.

One of the best reasons to refinance is to lower the interest rate on your existing loan. Historically, the rule of thumb was that it was worth the money to refinance if you could reduce your interest rate by at least 2%. Today, many lenders say 1% savings is enough incentive to refinance. Reducing your interest rate not only helps you save money, but increases the rate at which you build equity in your home, and can decrease the size of your monthly payment. For example, a 30-year fixed-rate mortgage with an interest rate of 9% on a $100,000 home has a principal and interest payment of $804.62. That same loan at 6% reduces your payment to $599.55.