Common Reasons and Drawbacks of Loan Refinancing

Loan-Refinance

Ned Demetriou, Negosentro |  Refinance means using a new loan to pay off an existing loan. This means that the old loan is replaced by a new loan with different terms. Refinance is mainly done to move on to a new loan with better features. The crux of the matter is that the debt gets transferred to a new loan. Companies often go for loan refinancing, so do individuals who are paying off a regular mortgage on the home loan, car loan or student loan and are finding it difficult to maintain an acceptable financial health. Refinance is chosen by people due to the many benefits associated with it.

 

Some of the common benefits have been mentioned here:

Low-interest rate – The low interest rate is the most common reason for loan refinancing. People often move on to loans offering a lower interest rate than the existing loan. Thus, they can save a lot of money that otherwise goes on the payment of interest. However, it is necessary to be able to calculate the costs of refinancing before determining whether the lower interest rate is saving any money or not. In case of long term loans and large loan amounts, the lower interest rate is highly beneficial.

Reduced monthly payments – Refinancing leads to lower monthly repayments due to lower interest rate and the extension of time required to repay the loan. Consequently, the financial burden on the individual is relaxed to some extent because more cash is available for other monthly expenses. Managing monthly budget becomes much easier. This improves the financial health of the borrower.

Obtaining extra cash – There are times when one requires extra cash for various purposes such as new investments, wedding, college admission, etc. In such cases, refinance is a suitable way of securing extra cash without hassles.

Faster loan repayment – Loans with long repayment time periods can be reduced by refinancing. There are times when people want to pay off their debt quickly due to greater availability of money as a result of the improved financial condition. They can make extra payments without going for refinancing, but extra mortgage payment may not be allowed in many loan terms. In such situations, refinancing by opting for a lower term loan is an appropriate course of action to get rid of the mortgage as soon as possible.

Consolidating debt – People often get stuck in a quagmire of multiple loans such as car loans, personal loans, credit card loans, home loans and many others with different interest rates and terms. Refinancing helps in consolidating all the loans into a single loan with a lower interest rate. By consolidation of multiple debts, one can sustain regular mortgage payments without incurring a penalty and avoid high-interest rates. Managing finances is also made simpler.

Transferring to a different loan type – Refinancing is also considered when the borrower wants to change the mortgage from fixed interest loan to variable interest loan and vice versa. Refinancing helps in getting a type of mortgage which is best suited to the person’s preference and requirements.

Paying off a loan which is due – A Loan which needs to be repaid by a particular date can be paid off by refinancing when the borrower does not have the funds to meet the deadline. Refinancing clears the debt and offers more time to the borrower for clearing the new loan.

There are also some drawbacks of refinancing. Some of them are as follows:

  • The transaction costs of refinancing may prove to be hard to the pocket. Thus, it is necessary to ensure that long term savings are more compared to the short-term costs before going for refinancing.
  • Despite lower interest rate, the longer period of the loan means that the borrower pays more interest.
  • Beneficial features of some loans are lost due to refinancing.
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