Loan Refinancing

What you need to know about refinancing loans

If interest rates have dipped sharply since you took out your loan or mortgage, or if your monthly payments are more than you can comfortably afford, loan refinancing may be an option for you. Conversely, if you're in a position to pay more per month than you were before, loan modification can save you thousands by freeing you of your debt sooner.

How Loan Refinancing Works

Loan modification allows you to change your repayment terms by extending or shortening your loan term. This will affect the amount of time it will take to amortize your loan and, by extension, the amount of your monthly payments. Your modified loan may also be subject to a different interest rate to reflect changes in the market.

The lender overseeing your loan refinancing may charge you points to complete the change. Points are, essentially, percentages of the entire loan amount which must be repaid up front. This structure is commonly used in refinanced mortgages. It is common in home equity loan refinancing, for example, to be given a choice between various combinations of points and interest rates.

Should I Refinance?

There are many reasons people refinance loans. Loan refinancing can be done in order to:

  • Extend your repayment period
  • Free up money to pay down other debts, such as credit cards
  • Reduce your level of risk; for example, you might refinance a variable rate mortgage by going to a mortgage with a fixed rate
  • Lower your monthly or quarterly payments

There are some risks inherent to loan refinancing, especially mortgages. Mortgages often have built-in penalties (known as call provisions) which force you to pay extra if you clear the debt ahead of schedule. When you refinance a loan, you're essentially borrowing all the money you need to pay off the existing loan, then paying down a new loan or mortgage with different terms. Thus, you'll trigger any call provisions in your first loan or mortgage when you refinance it. This can cost thousands of dollars.

To determine whether or not you should refinance, you'll need to sit down and figure out the total cost of paying off the refinanced loan versus your current loan. Remember that lower interest rates don't always lead to saving money. This is true not only of mortgages, but also of auto loan refinancing and student loan refinancing.

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