The financing of loans is a crucial subject, both in the world of big business and within a working family. Loans are often necessary to pay for a car, house or a college education. It is often the case that over time, financial situations change and the initial terms a loan was taken out under are no longer ideal. In such cases, it may be a good decision to refinance such a loan. To refinance a loan is essentially to take out a second loan to pay the first off, hopefully with more favorable terms. This process can be undertaken for a variety of reasons and with a variety of goals, depending on circumstances.
Features
The features of a refinanced loan are determined by the same terms as any other loan. The principal, or loan amount, is paid back over a set period of time at a calculated monthly payment amount. Though the loan may be paid back at a rate greater than that dictated by the minimum monthly payment, many loans have built-in fees for premature payment. The interest rate and time period of a loan determine how much money above the principal must be paid to pay off the loan. In addition to these factors, the refinancing of a loan, such as a home mortgage, will often affect your available income tax deductions.
Types
The refinancing of a loan may be undertaken for a variety of reasons. If interest rates have fallen since the original loan was taken out, it may be possible to refinance at a lower interest rate and thus save money in the long term. If debt from multiple sources is an issue, it may be possible to refinance this debt into a single loan with an acceptable interest rate and payment period. Debt from high-interest rate lenders, such as credit card debt, may be refinanced using a second loan with better terms. Refinancing may also be done to reduce risk, by switching from adjustable to fixed interest rates. In addition to these types of refinancing, a loan may also be refinanced if one wishes to pay it off in a shorter period than the loan's terms dictate.
Potential
Refinancing allows flexibility in the repayment of a loan or debt. In personal finance, this has the potential to make or break one's financial future. Certain types of high-interest debt, such as credit card debt, may require significant payments each month just to prevent further accumulation of debt. Refinancing such debt into a loan with a lower rate of interest and longer payment period can allow cash flow to be significantly increased and the total amount of money paid to creditors drastically decreased. If a large loan with a long period of maturation, such as a home mortgage, were taken out under unfavorable conditions, a new, refinanced mortgage can mean increased cash flow throughout the loan's lifetime, as well as a lower amount paid overall.
Considerations
Whether or not a loan or debt should be refinanced is ultimately a personal financial decision, depending on the type of loan being refinanced, several factors should always be taken into account. Chief among them is the cost of refinancing. Because lenders depend on interest to make money off of a loan, they often include fees for prepayment within a loan's terms. This way, they ensure a profit even if you were to pay off a loan right after signing the contract. In the case of a home mortgage, it is important to calculate how much money will be saved over time by refinancing and weigh this against how long you plan to occupy the house. This way you can determine how long you must live in your current residence after refinancing to save money.
Warning
Whether the decision in question is whether to refinance at all or what terms you wish to change by refinancing, the gravity of the decision requires extensive research and sober deliberation before any course of action is decided. Whatever terms you end up agreeing to when you refinance a loan will likely dictate your financial situation for years to come, and should be carefully weighed in regard to benefit and risk.
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