Most people are familiar with the term refinancing. This process allows borrowers to save money by reducing fees and interest.
Refinancing is the process of switching a debt, such as a mortgage or your personal loan over to a new loan with different – more favourable terms. This is most commonly done in order to save money or get better terms on your current loan. People choose to refinance their loans or mortgages for a variety of reasons including to fold-in other debts, to lower monthly payments, or to take advantage of better interest rates. While it is usually a winning situation for the borrower one should be aware of the advantages and disadvantages to taking on a refinance.
Advantages of refinancing
- Refinancing can reduce the amount of interest you pay on your debt moving it to a loan with a lower interest rate.
- Extending your repayment time, which also reduces your monthly payment.
- Folding-in other debts, thereby reducing interest and fees. If you are paying high interest on credit card debt you can significantly reduce your interest fees by folding it into a personal loan or refinanced home loan.
- Lower the risk associated with a loan by switching to a fixed rate instead of an adjustable rate loan. Doing this helps you budget for your monthly bill and removes the chance of your bill being higher then you anticipated each month as it adjusts to the market rates.
Drawbacks of refinancing
- Often loans will have penalty clauses that may wind up being costly. Because the process of refinancing first pays off your old loan and then opens a new loan you could be subject to some of these early repayment costs.
- There may be closing and transactions fees for any refinance. Usually, any amount you save in interest should make these fees worthwhile, but any borrower should carefully add up their costs and savings to be sure.
- Some refinance loans have low payments but wind up extending the life of the loan to a point that they actually cost more money then your original loan. By carefully calculating all of these costs and doing a comparison you can avoid this trap.
There are two types of refinancing loans, a No-Closing Cost loan allows you to move your debt to a new loan with little cost. If you’re interest rate will reduce by only 1.5 percentage points it is cost effective to do a No-Closing Cost refinance. Also, realise that even though you are paying nothing up front, the lender is probably collecting extra moneys in the form a yield spread premium. Check into this to make certain you are not overpaying on your loan.
The second type or refinance is a Cash-Out. This will usually not save you money, instead you are refinancing a larger amount of money and then keeping the cash difference. Borrowers do this to pay off other debts or to make improvements on their homes.
Refinancing can be a great option for saving money on your loan. Be smart about your decisions and calculate all the costs associated with it before you take on the new loan. Far too many people think they will save loads of cash only to find themselves in worse circumstances then before their refinance. All that can be avoided by diligent research and some financial smarts.