What do you think of when you hear the word “refinancing?”
If you’re like most people, your first thought might be that it has something to do with a mortgage. And you’re not wrong! However, refinancing can apply to many different types and forms of loans. In this article, we will explore what refinancing is, how it works, and when it can work to your advantage.
What is refinancing?
Refinancing is the process of transferring all or part of an existing loan from one loan to another. This is done in order to achieve a…
- Lower interest rate
- Lower monthly payments
- More favorable repayment period
- Or all of the above
Let’s consider an example. Say you have a $10,000 loan with a 5% interest rate and a 10-year term. You’ll pay $106 every month to service the debt, and over $12,000 in total once interest is included.
But you think you can do better! You find someone else who’s willing to loan you $10,000 at a 2.5% interest rate over a 10-year term. You’d save more than $1,000 in interest and pay less every month. That’s a far better deal.
So, you would borrow money from your new creditor and use that sum to eliminate your existing loan. You’ve used another loan to decrease your interest burden and increase your cash flow. That’s the power of refinancing in a nutshell. It’s often worth the effort if you can decrease your interest rate without increasing your term.
But it may not be a silver bullet for your debt.
Refinancing only works if you can score a new loan with a more favorable contract. There may be times when interest rates are high and finding lower rates simply isn’t possible. Even then, a lower interest rate may not offset the costs of a longer loan term.
That’s why it’s always best to work with a financial professional before you refinance any loan. Their expertise can help you determine whether refinancing will help or hinder your progress towards your financial goals.