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So, what’s refinancing, anyway? You hear a great deal about refinancing from lender ads, and you no doubt receive emails and junk mail asking you to refinance your mortgage or other big loans you might have. However, despite all the advertising, many people still don’t understand how it works or how it can benefit them. Loan refinancing can help borrowers lower their monthly payments, shorten the duration of loans, and reduced extraneous loan costs they may be paying out of pocket for things such as private mortgage insurance. You can even get much-needed cash from an effective loan refinance. Learn a bit more about refinancing and perhaps put it to work for you.
How Refinancing Works
Loan refinancing refers to the act of paying off an existing loan by taking out a new loan. The new loan won’t erase the previous loan’s debt. However, if done correctly, the new loan terms should benefit the borrower in one form or another. Doing this effectively can help a borrower improve his or her financial position; in some cases, it can even help a borrower become debt-free. However, there can be costs or pitfalls associated with refinancing, regardless of the rationale.
One of the top reasons borrowers refinance loans is to lower their monthly payments. Borrowers can reduce the amount they pay to service a loan each month by either refinancing a loan at an interest rate lower than their current loan or by increasing the length of the loan. In some cases, the loan will feature both of these options. However, while a lower monthly payment may be a critical and necessary step for borrowers in tough financial situations, it’ll likely lead to a longer payment timeline as well; you’ll have lower payments each month, but you’ll stay in debt longer.
Shorten Loan Timelines
Conversely, some borrowers refinance loans so that their repayment horizon shortens, and they pay the loan off quicker. Doing this in a shorter time frame – such as a 30-year to a 15-year mortgage – will save you large sums in interest and means you’re out from under the debt in about half the time. However, unless interest rates dropped considerably between the original loan and the time you refinanced, chances are strong that you’re going to have a larger monthly payment.
Streamline Your Debts
Another reason people choose to refinance their loans is to make repaying their debts more manageable. For example, if you have multiple student loans, keeping track of all those different payment amounts and due dates can be challenging. If you consolidate all those outstanding debts into a new single loan, you can streamline your debt repayment plan. In addition to student loans, people also refinance to consolidate credit cards and other debts, and many lenders specialize in debt consolidation loans for this purpose.
Borrowers also choose to refinance to obtain quick infusions of cash. Homeowners who have considerable equity in their homes can refinance the loan for more than the balance on the current loan; they can then use the additional cash for other critical purposes in their lives, such as home improvements or starting a business. This practice is often called cash-out refinancing. While it can be a good way to use your home to finance one of your life’s priorities, keep in mind that your new loan will carry a higher balance than what you owed on the original loan.
Get a Better Deal or Lender
Sometimes, you just get tired of a lender. If your lender isn’t responsive when you have questions or issues with your payments, occasionally fails to credit your payments and then charges late fees, or is just plain difficult to deal with, it may make sense to refinance your loan and work with a different (and hopefully better) lender. Additionally, refinancing when you’re in a better financial position can save you some money each month. For instance, if you originally had to take out private mortgage insurance (PMI) because of a low down payment, you may be able to save yourself that expense with a new loan. Borrowers often do this to lock into a low fixed-rate loan, instead of contending with an adjustable interest rate. Therefore, if you want to get a better lender or a better deal on your loan, it may make sense to refinance.
To Refinance or Not to Refinance
If you’ve asked yourself “what’s refinancing” recently, we hope that this article answered some of your key questions about the practice. Borrowers refinance all different types of loans for a variety of reasons, but they’re usually attempting to improve their financial situation. However, there can be some drawbacks and costs associated that you’ll have to be prepared for. Do your homework and find out if refinancing is a good choice for you.