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What Does Refinancing Mean?

Here is what refinancing is, its benefits and its drawbacks.

Getting a new loan replaces an existing one and pays off the debt of the latter loan fully to the initial lender. You now owe and pay your debts to a new lender. That is what refinancing means. The new loan taken improves your finances (in theory), as it should have better and more ideal features than the previous one.

It is possible to refinance any kind of loan, whether it is an auto loan, a home loan, or any other, for that matter.

It is only sensible to refinance a loan if it lowers your monthly payment by giving you a lower interest rate than your original interest rate. If a quick loan amortization is done, it will help you see how the interest costs change with different loans, giving you a rough idea of the rates and terms you are looking to find in a new loan.

Benefits of Refinancing

You can either lower the interest rate on your loan or extend the time required to pay it off. Whatever you decide, the result is more often a healthier monthly cash flow and more money being available for your other monthly expenses.

Another thing that refinancing makes possible is consolidating several different loans into one single loan. This makes it easier to calculate and keep track of your loan payments. You won’t have to worry about calculating and paying off multiple loans to multiple lenders. Instead, you pay monthly payments on a single loan to a single lender.

One more thing that can be done is to switch to a fixed rate of interest from a variable-rate loan. Getting a fixed rate means your monthly payments will remain the same even when general interest rates rise. Fixed rates could also mean staying on a higher interest rate if interest rates in the economy do fall.

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Drawbacks of Refinancing

Refinancing has its drawbacks too. Some lenders impose high penalty fees if you pay off your mortgage earlier than your term-ending date. The amount of these penalties vary from lender to lender but can add up to thousands of dollars. This means even if you are completely capable of paying back your debts, you won’t be able to do so before you reach the end of your term.

When you close a loan, you are required to pay closing costs. These include title fees, credit check fees, appraisal fees, and more. Before you apply for refinancing, you must calculate all of these addition costs. Make sure you can afford to pay them on the new loan with the money you have in your budget.

Another drawback of refinancing occurs when you choose to extend the length of your loan term by favoring a lower interest rate or some other benefit. This could become problematic, and you could be stuck with paying off the debt for a more extended period of time. You might even end up paying back much more than what you initially would have paid.

Refinancing can also hurt your credit score. The lenders make a hard credit inquiry in order to refinance, which leads to a few points dropping on your credit score. However, this is temporary and doesn’t affect your score forever.

Should You Refinance Your Loans?

Is it a good idea to refinance your loans? Well, that depends on your financial situation. You must assess your present situation, take a closer look at all the possibilities and then decide whether you really need to refinance or not.

Consider all the advantages and drawbacks of refinancing. Only go for it if it leads to significant savings or if you think the other advantages are worth it.

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Written By

Riley is a finance, lifestyle, and entertainment writer living in San Diego. He received his bachelor's degree in Journalism and Multimedia from the University of Oregon. His work has been featured in many finance and lifestyle publications throughout the US. When he is not writing, Riley enjoys reading and hanging out at the beach with his dog, Miles.

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