In the simplest terms, refinancing a loan means replacing a loan you already have with a new one, typically with new terms. People refinance loans for various reasons, such as to restructure debt, save money, and get on a payment schedule that's a better fit.
There are advantages and disadvantages of refinancing home loans, as well as auto, student, and personal loans. So, in this article, our financial pros cover the basic refinance meaning with examples to help you understand your financial options.
How Refinancing Works
The process of refinancing personal loans and other types of loans starts with submitting an application to a lender. You'll submit a refinancing application complete with your financial details so the lender can evaluate your credit history, debts, and income.
If the lender approves your application, you’ll receive a new loan, typically with different terms than your existing one. The new loan pays off your old one, so then you’ll only be responsible for making payments on your new loan.
For example, if you refinance a $10,000 loan from 10% to 8% interest, you can lower your monthly payments and reduce the total interest you must pay. The Consumer Financial Protection Bureau advises that refinancing to replace an old loan with a new one can come with better terms, but not necessarily, as there are usually tradeoffs.
Benefits of Refinancing
Now that you understand the answer to “What is refinancing a loan?", what are the potential benefits of refinancing?
Lower Interest Rates
If you can secure a lower interest rate through refinancing, you can cut the total cost of borrowing money over time. Then, you can use the money you save on interest to contribute to an emergency fund, retirement account, or pay for other expenses.
Reduce Monthly Payments
When you refinance, you can extend the repayment term with your new loan. A longer term can mean lower monthly payments that are more manageable with your budget.
Shorten or Extend Repayment Terms
Refinancing personal loans and other loans can shorten or extend your repayment terms. A shorter term is helpful if you want to pay off your debt faster. However, a longer term can curb the strain on your budget if you need more financial flexibility.
Access Cash for Expenses
Do you get money when you refinance a loan?
If you pursue a cash-out refinance, you borrow more money with your new loan than what you currently owe. Then, you receive the difference in cash, which you can use for home improvements, bills, or something else.
Drawbacks & Considerations
However, there are also disadvantages of refinancing home loans that may apply to your unique financial situation. Here are some considerations to keep in mind before you refinance to ensure it’s a cost-effective decision.
Upfront Costs
Refinancing isn’t free, as there are fees that generally apply when you choose to take out a new loan. You may also have to pay closing costs or penalties, so understand what these costs are so they don’t outweigh the savings of refinancing.
Long-Term Costs
In addition to these initial costs, there are also long-term costs associated with refinancing a loan. If your new loan extends your repayment term, you could end up paying more in interest over time than you would have with your original loan.
Credit Score Impact
Refinancing can affect your credit because the application process requires a hard credit inquiry and opening a new account. These factors can cause your credit score to temporarily drop, but the impact is short-term.
Is Refinancing Right for You?
As you weigh the advantages and disadvantages of refinancing a home loan or other loan, consider your current situation and whether refinancing makes sense right now.
For example, refinancing may be a good choice if you qualify for a significantly lower interest rate. It also makes sense if you've improved your credit score since receiving your original loan. However, you must ensure that you have a stable income to stick to a new loan's repayment terms.
However, applying for refinancing may not be the best idea if you are nearing the end of your current loan and almost able to pay it off. If the fees and penalties associated with getting a new loan outweigh the savings, it's likely not a good time to refinance. Meanwhile, if you are uncertain about your job situation and worried about income, you might want to hold off on refinancing until you feel more secure.
Refinancing Options by Loan Type
Here are some additional details about the refinance meaning with examples about how refinancing works with a mortgage, auto loan, personal loan, or student loan.
Mortgage Refinancing
To refinance a mortgage, you can consider a rate-and-term option, which involves getting a lower rate or a new term. You can also choose a cash-out option to access equity or a streamline option to simplify the refinancing process for certain loans.
Auto Loan Refinancing
Automobile loans replace your current vehicle loan with a new one. Drivers often choose this option to lower their monthly payments and interest rate.
Personal Loan Refinancing
When you have a personal loan, like the ones we offer at Service Loan South, you might qualify for better terms when you refinance. You can contact us to learn more about refinancing options and how to restructure your personal debt.
Student Loan Refinancing
There are also opportunities to refinance student loans and to combine federal and private loans into just one loan. You might get a lower rate, but at the expense of income-driven repayment and other federal protections.
Alternatives to Refinancing
Refinancing a loan works well for many people, but there are other options if you are uncertain if refinancing is right for you.
For example, you can inquire with your current lender about loan modification, which involves working with your lender to adjust your existing loan’s terms. Service Loan South’s personal loans can also serve as a refinancing alternative because they can consolidate debt and help you pay for urgent expenses without refinancing.
Another option is to look into a secured credit card or credit-builder loan. These refinancing alternatives can help you improve your credit health and put you in a stronger financial position for the future. You can also see if a balance transfer credit card is a good fit for your financial situation, especially if you qualify for a promotional interest rate and can pay off the balance promptly.
Why Choose Service Loan South?
It's important to remember that refinancing a loan can be a valuable tool, but that many financial options are available to help you take control of your debt.
Service Loan South offers simple, short-term personal loans to help you consolidate your debt and afford expenses outside your budget. For many people, our personal loans offer a viable financial solution without the drawbacks or complexity of a refinance.
We are a trusted loan company with flexible personal loan options and helpful customer service every step of the way.
Apply online today or visit a local Service Loan South branch near you to get personalized support with a loan that meets your needs.
FAQ Related to “What Is Refinancing a Loan?”
At Service Loan South, all our local branches are staffed with friendly and knowledgeable loan professionals who can tell you more about personal loans and refinancing options. Here are answers to some of the most common questions our customers ask us.
What Does Refinancing a Loan Do?
When you refinance a loan, you replace an existing loan with a new one, typically to obtain one or more advantages.
Is Refinancing a Good Idea?
Refinancing is a good idea for many people, but it's not the right solution for everyone. Consider whether the long-term savings outweigh the fees and costs of pursuing a refinance.
Do You Get Money When You Refinance a Loan?
In some instances, such as a cash-out refinance, you can get money back when refinancing a loan. With a cash-out refinance, you borrow more than you owe and then get cash back to use however you wish.
Does Refinancing Hurt Your Credit?
It is possible for refinancing to cause a temporary dip in your credit due to the hard inquiry required. However, your credit score should bounce back over time when you make new loan payments on time and according to the agreed-upon terms.
