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- The Secret About Prescriptive Easement: Top Guide 1 Must Know - December 4, 2023
- About Home Equity Loans In Texas And How Can One Obtain It - November 27, 2023
What Is Refinancing?
The process of revising and replacing the terms of an ongoing credit agreement that is related to a loan or mortgage is called refinancing or refi.
When a business or an individual decides to refinance a credit obligation, it is for the purpose of making favorable changes to their interest rate, payment schedule, and/or other terms outlined in their contract.
When they get approved, the borrower gets a new contract in place of the original agreement.
When the interest-rate environment changes the borrowers often choose to refinance, so they can save on debt payments from a new agreement.
How does a refinance work?
Refinance is opted by consumers to seek certain debt obligations in order to obtain more favorable borrowing terms, which is more likely in response to shifting economic conditions.
Either for lowering one’s fixed interest rate or 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 refinancing is done.
Borrowers may also refinance because of an improvement in their credit profile, or because of changes made to their long-term financial plans, or to pay off their existing debts by consolidating the debts into one low-priced loan.
The interest-rate environment is the most common motivation for refinancing. As interest rates are cyclical when the rates drop many consumers choose to refinance.
National monetary policy, the economic cycle, and market competition are some important factors causing interest rates to increase or decrease for consumers and businesses.
And these factors influence interest rates for all types of credit products, including non-revolving loans and revolving credit cards.
Debtors with variable-interest-rate products land up paying more in interest during the rising-rate environment and in a falling-rate environment, the reverse is true.
If they want to refinance, a borrower must approach their existing lender or a new lender and request a completely new loan application.
Refinancing happens when an individual’s or a business’s credit terms and financial situation are re-evaluated.
The common consumer loans that are considered for refinancing consist of mortgage loans, car loans, and student loans.
Mortgage loans on commercial properties are also sought for refinancing by businesses.
The business investors evaluate their corporate balance sheets for business loans issued by creditors so they can benefit from lower market rates or an improved credit profile.
Types of refinancing
There are several refinancing options. Depending on the needs of the borrower the type of loan is decided by the borrower. Some of these refinancing options are:
Rate-and-term refinancing:
Being the most common type of refinancing, this refinancing takes place when the original loan is paid and replaced with a new loan agreement that consists of lower interest payments.
Cash-out refinancing:
These refinance are common when the underlying asset that collateralizes the loan has gone up in value.
The transaction involves taking out the value or equity in the asset in exchange for a loan with a higher amount and higher interest rate.
Meaning, when the value of an asset increases on paper, then instead of selling it you can gain access to that value with a loan.
Though there is an increase in the total loan amount with this option but the borrower has to access cash immediately while he still maintains the ownership of the asset.
Cash-in refinancing:
This type of refinancing allows the borrower to pay down some portion of the loan for a lower loan to value (LTV) ratio or smaller loan payments.
Consolidation refinancing:
Consolidation of a loan may be an effective way to refinance in some cases.
When an investor obtains a single loan at a rate that is lower than their current average interest rate across several credit products then a consolidation refinancing can be used.
In this type of refinancing the consumer or business are required to apply for a new loan at a lower rate and then pay off existing debt with the new loan, by leaving their total outstanding principal with substantially lower interest rate payments.
The Pros and Cons of refinancing
Pros
- Provides the borrower with a lower monthly mortgage payment and interest rate.
- An adjustable interest rate can be converted to a fixed interest rate, gaining predictability and possible savings.
- A borrower can obtain instant cash for an imperative financial need.
- An opportunity to set a shorter loan term, that allows borrowers to save money on total interest paid.
Cons
- If the borrower’s loan term is reset to its original length, then the total interest paid over the life of the loan could outweigh what they save at the lower rate.
- If the rate of interest drops, the borrower will lose on the benefit with a fixed-rate mortgage unless they refinance again.
- Refinancing may reduce the equity that a borrower hold in their home.
- The borrower’s monthly payment increases with a shorter loan term, and they might have to pay closing costs on the refinance.
Corporate refinancing
When a company reorganizes its financial obligations by replacing or restructuring existing debts then the process is called corporate refinancing.
This refinancing is usually done to improve a company’s financial position and help the company which is in distress with debt restructuring.
With corporate refinancing, the older issues of corporate bonds are called in and new bonds at lower interest rates are issued.
Conclusion
When the terms like the interest rates, payment schedules, or other terms, of an existing loan, are revised a refinance happens.
When interest rates fall that is when borrowers tend to refinance. Refinancing requires the re-evaluation of a person or business’s credit and repayment status.
The consumer loan that is often considered for refinancing is mortgage loans, car loans, and student loans.
