Refinancing Information
Identification
Refinancing is a process that exchanges one loan for another loan with a different interest rate and repayment terms. Mortgage and vehicle refinance loans are the most common, but consumer or debt consolidation loans fit the description as well.
How It Works
The process of refinancing a loan is much the same as when you applied for the original loan. First, you establish eligibility, then gather documentation and fill out the new loan application. Establishing eligibility can be as simple as checking your credit rating or it can involve additional steps. For example, with a mortgage refinance, you also need to determine the loan-to-value ratio of your home to make sure the value of your home supports the loan request. Documentation includes information, such as a vehicle title, home appraisal or land survey. Upon approval and payment of any associated fees, loan proceeds pay the remaining balance of the previous loan and you begin repaying the new loan.
Purpose
Refinancing serves three main purposes. The first is to take advantage of a lower interest rate. Refinancing at a lower interest rate reduces monthly payments and the overall cost of a loan. The second purpose is to change the number of payments. Reducing the number of remaining payments lowers the amount of interest you pay and in turn reduces the overall cost of the loan. Extending the number of payments will increase the cost of the loan but may reduce monthly payments. Finally, refinancing can serve the purpose of combining and consolidating existing debt.
Considerations
Think about whether refinancing your loan makes sense. Even if you can get a lower interest rate, refinancing is not always the best idea. In the case of a mortgage refinance, the Federal Reserve Board recommends you also consider how much time remains in your current mortgage, whether your current mortgage includes a prepayment penalty and how long you plan to remain in the home before deciding to refinance. In addition, unless the new loan reduces the number of payments, refinancing will most likely extend the time you are responsible for making monthly payments. Most of the time, the fewer payments you have remaining on the original loan and the less time you plan to keep the home or vehicle, the less sense it makes to refinance.
Risks
In some situations, refinancing can be dangerous. This is especially true when your purpose is to consolidate debt, and even more if you pledge the equity in your home as collateral. The National Consumer Law Center recommends approaching debt consolidation loans with caution. In addition, the organization discourages using your home as collateral to refinance unsecured debt. Putting your home at risk to pay credit card debt and medical or utility bills can have disastrous results. If you do make this choice, the NCLC reminds you that federal law gives you a three-day period to change your mind and cancel the refinance loan.
Source: livestrong
