- To refinance means to take out a new loan to pay off an existing one, usually in order to get better interest rates or repayment terms.
What does Refinance mean?
To refinance a loan means to take out a new loan to cover the costs of an existing one. Borrowers do this to secure lower interest rates and repayment terms. However, there are fees associated with refinancing a loan, whether it’s a mortgage, auto loan, or personal loan. When deciding whether or not to refinance a loan, you’ll want to make sure the fees don’t exceed the savings you may get in interest.
What kinds of loans can be Refinanced?
Refinancing is most often applied to mortgages. Other types of loans that can be refinanced include personal loans, bank loans, auto loans, student loans, and even credit cards.
How does Refinancing a loan work?
The refinancing process will depend on the type of loan and the lender:
Mortgages—When refinancing a mortgage, it’s important to consider how much it will cost, and how much you might save on interest. Make sure to check closing costs, appraisal fees, and other charges associated with refinancing. The general rule is that saving even one percent on interest after all the fees are paid may mean refinancing is worth it. Use this refinance calculator to see if this is the right option for you.
Bank Loans—Certain banks may agree to lower your interest or monthly payments depending on your situation. Ask your bank about their policies and special offers. If they don’t have any, or won’t negotiate with you, start shopping around for a bank that does.
Auto Loans—Refinancing an auto loan may be difficult. As your vehicle ages, the value drops, and many loans are based on the value of the collateral or the risk associated with lending money. That being said, talk to your lender—or your bank if they aren’t the lender—to see what offers they may be willing to extend. It’s important to note that simply lowering your monthly payments may not be beneficial. It might make payments more manageable, but it may also extend the life of the loan, which would mean that you end up paying more in the long run. This could lead to paying much more for the loan than the vehicle is even worth.
Credit Cards—Keep an eye open for low-interest or even zero-percent interest introductory offers on credit cards. You may be able to transfer your balance on your current card to a new one and then pay it off while you’re accruing little-to-no interest. These offers don’t usually last forever, and odds are the interest rate will go up after a certain amount of time.
Student Loans—For student loans it’s best to speak with your lenders personally to see if they can lower your interest rate or consolidate your loans. This will depend on whether you have private or government loans. For more info, see this checklist for paying off student loans.
What are the benefits of Refinancing a loan?
The benefit of refinancing a loan is that you have the potential to save money on your interest rate, and possibly on your payments. This would require that you refinance to a new loan with a lower interest rate. With large loans like mortgages, decreasing your interest rate even by one or two percent can mean big savings.
Refinancing might also mean lowering your monthly payments. If you extend the repayment period through refinancing, it will likely result in lower monthly payments throughout the life of the new loan. Some people choose to shorten their loan term—for instance, some people choose to switch from a 30-year mortgage to a 15-year mortgage. This may mean higher monthly payments, but your loan will be paid off much sooner.
Another benefit of refinancing a loan would be to consolidate your debts and simplify your repayment. If you have several loans, you may be able to refinance them into one large loan making tracking and payment much easier. However, this can lead to longer repayment terms which might mean paying more over time than you would if you chose not to consolidate.
What are the risks of Refinancing a loan?
There are, however, some disadvantages to refinancing that you’ll want to watch out for. Transaction costs are one disadvantage. With a large loan like a mortgage, the transaction fees like closing costs, processing fees, or origination fees could end up totaling thousands of dollars. Another aspect of the refinancing prospect to be aware of, as mentioned above, is extending the life of the loan, which would result in more interest payments over time.
Ultimately, the terms and conditions for refinancing a loan will depend on the kind of loan it is, as well as the lender involved. Do your homework and make sure you’re aware of any fees or costs associated with refinancing, and how the decision will affect you long term.