Refinance

How does refinancing work? Types, Pros & Cons for BorrowersThe process of revising and replacing an existing credit agreement as per the current scenario is called as Refinance.

What does refinancing do?‍

Refinancing means revising and replacing the terms and agreements of an existing loan or mortgage with a new set of terms and conditions. When a borrower decides to refinance his loan or mortgage, he does so to get more favorable terms, interest rate, payment schedule and other agreements that will benefit him. 

Refinancing is typically done when the interest rate in the market changes substantially and the borrower gets a chance to save more on his debt payments from another agreement. During this process, the borrower’s existing credit report and repayment status is checked before he is offered any revisions on the loan terms.

Most common forms of loans that are refinanced are mortgage loans, student loans and car loans. 

How does refinancing work?‍

A borrower typically chooses to refinance their loan when there is a substantial change in the interest rate environment in the market. When the interest rates drop, the borrower may choose to refinance his loan so as to avail lower interest rates and save more on debt payments. They can also choose to refinance when their credit profile has improved and they are allowed to get a refinance at a lowered interest rate. 

Whichever the case be, the procedure to refinance a loan is pretty straightforward. The borrower can either approach his existing lender for a refinance or go to a new lender and fill out a new loan application. The lender will then go through the existing loan document and re-evaluate the credit report and financial situation. Once all the checks are completed and the borrower’s credit report qualifies for refinancing, the refinance is approved and the borrower shifts to a new payment plan with a new interest rate. 

What are the different types of refinancing?‍

There are different types of refinancing options available. The most common ones are:

• Cash-out refinance: In this type of refinancing, the borrower takes a larger amount of loan than the original mortgage loan amount. This is done when the value of the asset increases on paper and the borrower takes a loan to pay off the original mortgage amount and any amount left goes to the borrower. This way he only has to pay one loan and also pays off the mortgage.
• Cash-in refinance: In this, the borrower pays off a big portion of his home loan by getting a lower-loan-to-value ratio or smaller loan payments. 
• Rate and term refinance: The borrower can change the rate of interest and terms of loan through this type of refinancing. This is most commonly used by borrowers when the interest rates are low. 
• Reverse mortgage: This type of refinancing is meant for homeowners over 62. In this, the house remains in the name of the borrower and they do not have to make monthly payments. The interest and fees keep piling up and the loan is repaid when the homeowner leaves or dies. Then, the lender can either sell the house to get the loan amount recovered or the heirs of the homeowner can choose to pay it off. 
• FHA streamline refinance: This type of refinancing is available to homeowners with FHA loans wherein they can choose to lower their monthly payments after a credit check is done. 
• VA streamline refinance: This type of refinance is available to military veterans and active service members with VA loans. In this, they can choose to lower their interest rates and monthly payments and shorten their loan term. They can also choose to refinance with an ARM or fixed-rate mortgage. 
• USDA streamline refinance: This refinance option is for borrowers with USDA loans to lower their interest rates and change the loan terms without having to go through additional home appraisals and or inspections on the property.

What are the advantages and disadvantages of refinancing?‍

The advantages of refinancing for a borrower are:

• They can get lower interest rates and monthly payments.
• Borrowers can convert an adjustable rate mortgage to a fixed rate mortgage (or any other type of loan).
• They can save money on loan repayments. 
• The loan term can be shortened so that the total interest paid is also less. 
• Payments may become predictable for the borrower. 

However, there are certain disadvantages of refinancing too such as:

• If the loan term is reset to the original loan’s length, the borrower can end up paying more interest over the entire life of the loans even if the interest rate is lowered. 
• The refinancing costs may not be worth the effort. 
• The equity of the home may reduce for the borrower if he uses cash-out refinance.

Conclusion‍

Refinance is a very helpful option for people with limited savings and income. Depending on the needs of the borrower, the type of loan chosen will be different for everyone. It is important to remember that when you refinance, you are confident of paying off the new loan in the future and that the refinance cost doesn't outweigh the benefits. Borrowers must carefully consider the benefits and disadvantages of all types of refinance before choosing one.