What Does It Mean to Refinance a Loan?

September 14, 2020

The objective of refinancing is often to get a longer loan term in order to reduce monthly payments and secure a lower interest rate. Refinancing can be a great option for individuals who are having challenges with paying off their loans. Let us discuss exactly what refinancing a loan means.


What is Loan Refinancing?

This speaks to the process of getting a new loan to replace an existing debt obligation. The terms of the new loan are typically more favorable than the existing arrangement. The result of this process is a new payment structure, lower monthly payments, or a longer-term length. Institutions that offer traditional loans usually offer refinancing options as well. Bear in mind that loans such as mortgages and car loans are usually more expensive to refinance. These loans usually attract a much higher interest rate.


Why Refinance?

From what you have been reading thus far, you may already have an idea of the answer to this question. Borrowers refinance to secure a loan arrangement that is more compatible with their financial context or goals. In most cases, a refinance can lower interest rate. Straight off the bat, this makes the loan much cheaper for the borrower. Here is an example: 

A homeowner with excellent credit secured a mortgage in 2006 with a 30-year loan repayment period. Back in 2006, the interest on similar loans was around 7%. It is possible to secure a mortgage today with an interest rate as low as 4% if you have a great credit history. If this homeowner decides to refinance this mortgage, he will cut his loan interest down by 2% to 3%. This will result in incredible monthly savings.


How to Refinance a Loan

If you want to tap into the benefits of loan refinancing, you must first have a clear understanding of your current loan arrangement. You must gain knowledge of exactly how much you are paying under your current loan arrangement. It is also important that you find out if your current bank charges a penalty for early loan repayment. The penalty charged for early repayment can sometimes outweigh the benefits of refinancing. 


Final Words

Refinancing done well can offer great financial benefit. While you can refinance a loan to get a lower interest rate and a better payment structure, it is necessary that you fully assess your current arrangement as well as what will be involved if you were to refinance. It would be a great idea to consult with a financial expert before making moves toward refinancing your loan.

Rahul Iyer

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