REFINANCE
All About Refinancing
A refinance, or “refi” for short, refers to the process of revising and replacing the terms of an existing credit agreement, usually as it relates to a loan or mortgage. When a business or an individual decides to refinance a credit obligation, they effectively seek to make favorable changes to their interest rate, payment schedule, and/or other terms outlined in their contract. If approved, the borrower gets a new contract that takes the place of the original agreement.
Borrowers often choose to refinance when the interest-rate environment changes substantially, causing potential savings on debt payments from a new agreement.
Key Takeaways
- A refinance occurs when the terms of an existing loan, such as interest rates, payment schedules, or other terms, are revised.
- Borrowers tend to refinance when interest rates fall.
- Refinancing involves the re-evaluation of a person or business’s credit and repayment status.
- Consumer loans often considered for refinancing include mortgage loans, car loans, and student loans.
How it Works
Consumers generally seek to refinance certain debt obligations in order to obtain more favorable borrowing terms, often in response to shifting economic conditions. Common goals from refinancing are to lower one’s fixed interest rate to reduce payments over the life of the loan, to change the duration of the loan, or to switch from a fixed-rate mortgage to an adjustable-rate mortgage (ARM) or vice versa.
Borrowers may also refinance because their credit profile has improved, because of changes made to their long-term financial plans, or to pay off their existing debts by consolidating them into one low-priced loan.
The most common motivation for refinancing is the interest-rate environment. Because interest rates are cyclical, many consumers choose to refinance when rates drop. National monetary policy, the economic cycle, and market competition can be key factors causing interest rates to increase or decrease for consumers and businesses. These factors can influence interest rates across all types of credit products, including both non-revolving loans and revolving credit cards. In a rising-rate environment, debtors with variable-interest-rate products end up paying more in interest; the reverse is true in a falling-rate environment.
In order to refinance, a borrower must approach either their existing lender or a new one with the request and complete a new loan application. Refinancing subsequently involves re-evaluating an individual’s or a business’ credit terms and financial situation. Consumer loans typically considered for refinancing include mortgage loans, car loans, and student loans
The Pros and Cons of Refinancing
Pros
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You can get a lower monthly mortgage payment and interest rate.
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You can convert an adjustable interest rate to a fixed interest rate, gaining predictability and possible savings.
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You can acquire an influx of cash for a pressing financial need.
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You can set a shorter loan term, allowing you to save money on total interest paid.
Cons
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If your loan term is reset to its original length, your total interest payment over the life of the loan may outweigh what you save at the lower rate.
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If interest rates drop, you won’t get the benefit with a fixed-rate mortgage unless you refinance again.
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You may reduce the equity you hold in your home.
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Your monthly payment increases with a shorter loan term, and you have to pay closing costs on the refinance.
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