Loan refinancing occurs when a business or individual changes a debt repayment schedule. From a technical perspective, a former loan is void and replaced with a new loan which consists of new repayment terms.
Businesses that refinance tend to extend the maturity date of a loan. Refinancing a loan may involve paying a fee or penalty.
Some of the most common sources of debt among consumers include mortgages, student loans, and car loans. In every case, the borrower commits to making payments based on an interest rate. Company debts are no different. Among corporations, the most common types of loans are bonds, lines of credit, and term loans. In each case, the company and lender agree to a set of terms and conditions. These terms and conditions include details regarding the amount of the loan, the interest rate, the payment amount, and the repayment schedule.
During a refinance, these terms and conditions are revised, resulting in a change in the payment amounts and/or the repayment schedule. When a loan is refinanced, an old loan is paid off with a new loan, which includes the new terms. These terms may include new fees, which are in place to deter borrowers from refinancing unless absolutely necessary. The most common changes in loan terms and conditions include changes to the interest rate and maturity date.
Why do borrowers refinance loans?
Borrowers might choose to refinance a loan for a wide variety of reasons. One of the most common goals is to pay less in interest over the loan’s lifetime. Borrowers who secured a loan with a high interest rate may refinance if interest rates have dropped significantly. Though refinancing comes with a fee, it may be worth it to pay the fee for a lower interest rate.
Other borrowers may want to reduce or extend the duration of the loan. Perhaps your financial situation has changed and you would like to pay off your loan faster than you initially signed up for. This saves you interest money in the long run.
or switch a mortgage from an adjustable-rate to a fixed-rate. Often, the reason is contingent on both the type of loan and the borrower’s financial situation.
What types of loan refinances exist?
Borrowers have several different loan refinancing options, most of which depend on the type of loan and the borrower’s financial needs. One of the most common loan refinance arrangements is called rate-and-term. In this case, the original loan is paid with a new loan. Another common loan refinance arrangement is called the cash-out. Cash-outs are more likely when the underlying asset used as collateral for the loan increases in value. This type of refinance involves “cashing out” an asset’s value or equity in exchange for a greater sum. The borrower gets access to the asset’s additional value, which is added to the value of the loan as opposed to sold. The total loan amount increases, giving the borrower access to additional cash without having to sell the asset in question. Finally, another common type of loan refinancing is called cash-in. Cash-in refinance allows a borrower to pay the loan in smaller payments or for a lower loan-to-value ratio.