What is Loan Refinancing?

Loan refinancing involves taking out a new loan, usually with more favorable terms, in order to pay off an old one. Terms and conditions of refinancing vary widely. Refinancing is more commonly associated with home mortgages, car loans, or student loans. In the case that old loans are tied to collateral (assets that guarantee loans), they can be transferred to new loans. If the replacement of debt occurs under financial distress, it is called debt restructuring instead, which is a process to reduce and renegotiate delinquent debts to improve or restore liquidity. For more information about or to do calculations involving debt, please visit the Debt Consolidation Calculator or Debt Payoff Calculator.

Reasons to Refinance

Save Money—If a borrower negotiated a loan during a period of high interest rates, and interest rates have since decreased, it may be possible to refinance to a new loan with a lower interest rate. This saves money on interest costs for the borrower. It is also possible to refinance when a borrower’s credit score improves, which may qualify them for more favorable rates. This can in turn improve credit score even further if borrowers use the money saved to pay off other outstanding debts.

Need Cash—The balance of a loan will decrease during the payback process. When enough equity has accumulated, the borrower may cash out by refinancing the loan (mostly home mortgage loans) to a higher balance. However, refinancing normally requires the payment of certain fees. Unless accompanied with a lower interest rate, cash-out refinancing is normally expensive.

Lower Payment Amount—Borrowers struggling to meet the minimum monthly payments on a loan can refinance to a new loan with lower required monthly payments, which can help ease the financial burden. However, most probably, this will increase the loan term and increase the total interest to be paid.

Shorten the Loan—Borrowers can potentially pay off their existing loans faster by refinancing to shorter loan terms. One of the most common examples is refinancing a 30-year mortgage to a 15-year mortgage, which typically comes with a lower interest rate, though this will most likely result in a higher monthly payment.

Consolidate Debt—Managing one loan with a single payment date instead of multiple loans with multiple payment dates is much simpler. This can be achieved by refinancing multiple loans into a single loan (especially one that has a lower interest rate than all previous loans).

Switch from a Variable Rate to Fixed, or Vice Versa—It is possible to use loan refinances to make the switch from variable interest rates to fixed interest rates in order to lock in low rates for the remaining life of the loan, which offers protection from rising rate environments.

Refinance Mortgages

Refinancing a mortgage may come with different benefits such as getting a lower rate, switching from an adjustable rate mortgage (ARM) to a fixed mortgage, consolidating combo mortgages or other debt, removing someone from a loan (example being ex-spouse), and more, depending on the type of refinancing. Several types are explained in detail below.

Cash-Out Refinance—It is refinancing with a new loan amount higher than the remaining owed amount on existing mortgages. The difference goes to the borrower in cash. Generally, borrowers need at least 20% equity in their property to be eligible for cash-out refinances. As with most loans, there will be fees associated with cash-out refinances, typically hundreds or thousands of dollars, which should be factored into the decision-making process. Essentially, cash-out refinancing involves turning the equity built in a home into additional money. Some borrowers use the money for home improvements. Others may use it for situations such as medical emergencies or car repairs. It can also be used it to pay off credit cards or other high interest debts.

On the opposite side, borrowers can also contribute more money towards the settlement of a mortgage in order to reduce any remaining principal; this is referred to as a cash-in refinance.

FHA Refinance—While mortgages from the Federal Housing Administration (FHA) have less stringent down payment requirements, unlike conventional loans, mortgage insurance premium (MIP) (not to be confused with the additional upfront MIP that’s 1.75% of FHA loan value) payments are still required after 20% home equity is reached. This can be circumvented by refinancing from an FHA loan to a conventional loan after 20% equity value is reached, since conventional loans do not require MIP payments after this point. In some cases, this will result in a less costly loan and a smaller monthly payment. There is also an FHA Streamline Refinance in order to refinance an existing FHA loan into a new FHA loan, which usually results in a reduced rate. Note that a credit check is required, and the mortgage must be in good standing in order to use this option. For more information about or to do calculations involving FHA loans, please visit the FHA Loan Calculator.

Rate and Term Refinance—This method refinances the remaining balance for a lower interest rate and/or a more manageable loan term. This differs from a cash-out refinance. Rate and term refinances are common when interest rates drop.

ARM Refinance—Refinancing an ARM (when it is about to go through an adjustment) to a conventional fixed rate mortgage during a period of low interest rates can result in a new, more favorable loan. While ARMs usually provide a lower interest rate initially, they may rise during the latter stages of the loan due to changes in the corresponding financial index.

Mortgage Refinance Costs

When refinancing mortgages, there are a number of common fees that may apply. There is an input in the calculator to consider these in the subsequent calculations.

• Mortgage Application Fee—Lenders may charge about 1% of the loan amount to process mortgage applications, approved or not.
• Home Appraisal—Lenders usually require the appraisal of the house value in order to evaluate changes in value, and whether borrowers have enough equity for successful application. This typically costs a few hundred dollars.
• Loan Origination Fee or Mortgage Points—Normally 0-2% of the loan amount, used as compensation for putting loans in place.
• Documents Preparation Fee—On average, a few hundred dollars to pay for the preparation of important documents such as the Truth-in-Lending disclosure.
• Title Search—In the amount of a few hundred dollars, this fee is paid to a title company to research court records, prior deeds, and property databases to guarantee the title is free and clear of liens.
• Recording Fee—This is a charge for handling paperwork through counties or cities, and is usually a few hundred dollars or less.
• Flood Certification—In certain geographical areas, flood certification is necessary.
• Inspection Fee—This is a fee to evaluate the conditions or working order of the property (plumbing, electrical, pests, roofing, HVAC, and anything else that may apply). Usually a few hundred dollars.
• Survey Fee—A survey of the property ensures proper boundary lines to prevent encroachment by adjacent properties. An existing survey may be used. If a new survey needs to be obtained, expect to pay a few hundred dollars.

For more information about or to do calculations involving mortgages, please visit the Mortgage Calculator.

Refinance Student Loans

Before considering refinancing student loans, in the U.S., different repayment plans are available for those struggling to meet their payments; borrowers can change their standard repayment plan (10 years) to a plan such as one that is income-based (payment based on income), graduated (gradual increase in repayment), or extended (longer term). Students who find that they are unable to meet payments regularly may consider requesting deferment or forbearance, which can postpone required payments for some time. In specific situations, federal student loan debt can be completely forgiven, such as through the Teacher Student Loan Forgiveness program. When federal student loans are refinanced, they are no longer considered federal loans, but private loans, losing all the benefits of a federal loan.

Below are several other cases where refinancing a student loan may not be the best option:

• Irregular income
• Student loan interest rates are already relatively low
• The credit score is lower than 650

In the U.S., private student loans are generally not as flexible as federal loans, so refinancing the private student loan may result in a lower payment. Typically, private student loans, Grad PLUS loans, and Parent PLUS loans are most likely to benefit from being refinanced, since they usually have higher interest rates.

Student loan consolidation is different from student loan refinancing; the former is a special program offered by the Department of Education in the U.S. that allows all federal student loans to be combined into a single loan. Student loan refinancing is the process of taking out a new loan in order to pay off or replace other student loans. For more information about or to do calculations involving student loans, please visit the Student Loan Calculator.

Refinance Car Loans

It is possible to refinance a car loan in order to increase the length of the loan, thus reducing the size of the monthly payments. Although this gives borrowers a bigger window to pay off their car loans, it typically increases the cost of the loans because more interest will be paid.

When refinancing, beware of “upside-down” auto loans, which refer to loans that the amount owed is more than the book value of the vehicle. This can occur when refinancing to a longer loan, since the value of the car will decrease over the loan term, and the car may eventually be worth less than what is owed.

Some car loan agreements contain clauses for early termination, such as a prepayment penalty for paying off the loan early. It is important to account for these costs when deciding whether or not to refinance a car loan.

Car Refinance Costs

There may be an administrative fee (sometimes called an application fee) for terminating old car loans, as well as transfer of lien holder fees, and state re-registration fees. These fees can vary depending on various factors.

For more information about or to do calculations involving auto loans, please visit the Auto Loan Calculator.

Refinance Credit Cards

While credit card debt differs from the other loans mentioned in that it is a revolving form of credit, it can also be refinanced. One of the easiest ways to do so is to open a new balance transfer credit card. A balance transfer is a process of transferring high-interest debt from one or more credit cards to another card with a lower interest rate. There are balance transfer credit cards that allow a grace period (as an example, 12 months) of 0% interest on all balance transfers before they resume a usual interest rate (other types of 0% interest rate credit cards apply the 0% rate only to purchases, not balance transfers). Not everyone will qualify for 0% intro APR credit cards, but there are balance transfer credit cards without a 0% grace period that have lower interest rates, and people that cannot qualify for the former can try to qualify for the latter. The maximum amount of debt consolidated will depend on the new line of credit.

Credit card debt can also be consolidated into debt consolidation loans. Borrowers with good credit scores have a high chance of finding one with a low interest rate. For more information about or to do calculations involving a credit card, please visit the Credit Card Calculator. For more information about or to do calculations that involve paying off multiple credit cards, please visit the Credit Cards Payoff Calculator.

Refinance Personal Loans

Refinancing a personal loan can be beneficial if the new personal loan has a lower interest rate or a different repayment period. This is an option for borrowers if interest rates have declined, their credit has improved, they have higher income, or they didn’t get the best rate on their initial personal loan. Similar to the refinancing of other types of loans, whether it is beneficial or not will depend on whether the interest savings exceeds the charged fees for refinancing.

Technically, it is possible for a borrower to refinance a personal loan as many times as they can get approved for a new loan, though some lenders require that borrowers meet certain criteria in order to refinance a personal loan. One such criterion is requiring a borrower to pay down an original personal loan to 95% or less of the original balance before they are allowed to take out another personal loan. The application process to refinance a personal loan will take into account the borrower’s credit history and score, as well as their debt-to-income ratio. For more information about or to do calculations involving personal loans, please visit the Personal Loan Calculator.