What is Loan Refinancing?

Refinancing a loan allows a borrower to substitute their existing debt obligation with one that has more favorable terms. Through this process, a borrower takes out a new loan to pay off their current debt, and the updated agreement replaces the terms of the old loan. This enables borrowers to redo their loans for a lower monthly payment, different term lengths, or a more convenient payment structure. Most consumer lenders who offer conventional loans also offer refinancing options. However, refinancing loans tend to come with slightly higher interest rates than purchase loans for products like mortgages and car loans.

How a Refinance Works

Consumers generally seek to refinance certain debt obligations to obtain more favorable borrowing terms, often in response to shifting economic conditions. Common goals of refinancing are to lower one's fixed interest rate to lower payments over the life of the loan, to change the term of the loan, or switch from a fixed-rate mortgage to an adjustable-rate mortgage (ARM) or vice versa.

Borrowers may also refinance because their credit profile has improved, because of modifications to their long-term financial plans, or to pay off their existing debts by consolidating them into one low-priced loan.

What are some of the common reasons to Refinance?

Refinancing requires work, so is it worth the extra paperwork and costs? On the other hand, there are some great reasons to invest the time and money in a refinance:

• You can get a lower interest rate. — The most prominent reason to refinance is the prospect of lowering your interest rate. Whether your credit has improved dramatically since you first secured your mortgage or the market has evolved, access to a lower interest rate can save you lots of money throughout the loan. In today's climate, you're unlikely to save greatly unless you got your original mortgage ten years ago.
• You can get a different kind of loan. — Maybe you want to substitute the uncertainty of an adjustable-rate mortgage with a fixed-rate mortgage, or you're hoping to stop paying FHA mortgage insurance by switching to a traditional loan. Refinancing permits you to explore all kinds of home loans to find an alternative that works better for your finances.
• You can use your equity to borrow more money. — Refinancing might help you access more funds and save money. Cash-out refinancing allows you to leverage your accumulated equity to borrow a more significant sum. It can help you secure funding for substantial expenditures at a relatively low-interest rate.
• You can shorten your loan. — If you currently have 20 years left on a 30-year mortgage, you might want to refinance into a 15-year loan for a long-term savings opportunity. Your monthly payments could go up, but you'll settle your home loan quickly.