Table of Contents
- What is debt refinancing?
- Debt refinancing meaning
- Types of debt refinancing
- How does debt refinancing work?
- How does refinancing a debt help?
- Benefits of refinancing debts
- Disadvantages of refinancing
- Why you should not refinance
- Debt refinancing examples
What is debt refinancing?
Debt refinancing is the replacement of an existing loan with another loan at more favorable terms. The meaning of debt refinancing is to replace, or restructure, an existing debt to a new one. It is not the same as debt consolidation, which combines all your debts and interest rates into one new loan with a lower principal balance and new terms.
This is done because the borrower did not pay off the old loan and still owes money on it. Refinancing debt simply refers to the replacement of an old loan with a new one at different interest rates and terms (length and amount) and it is usually pursued when interest rates have dropped since the date that the original debt was issued. The reason for refinancing debt is typically to lower monthly payments or interest rates, shorten the length of the loan, change amortization schedules or get rid of fees and points. The process can take anywhere from a few weeks to over six months depending on how complex it is.
Debt refinancing meaning
The meaning of debt refinancing is to extend the time period of a loan and to change other terms such as interest rate or amount borrowed. It is an excellent way for borrowers with good credit history to save money on interest charges and this can be done by either going through a business that specializes in refinancing loans or by doing it directly through the debt refinancing company from which the borrower already has the loan.
Debt refinancing occurs when all of the following conditions are met:
- The original loan has not yet been repaid.
- A borrower still owes money on the original loan.
- Refinancing debt means you borrow against an asset (like home equity) to pay off other debt, like credit cards or student loans.
- When you are refinancing, you have 2 debts, the old loan with higher interest rate and the new one with lower interest rate; when approved of the new loan, it is now left for you to use the new loan to pay off the higher loan.
- Debt refinancing simply means you are allowed to get a new loan with a lower interest rate; but of course, it is not free, it comes with a fee or some charges.
Types of debt refinancing
- Credit Card Debt Refinancing: when you take out a new loan to pay off your credit card debt, whether at a lower interest rate or for a longer time period.
- Student loan refinancing: when a lender, such as a private lender gives you a new loan with a lower interest rate, after the lender pays your student loan.
- Auto Loan Debt Refinancing: When you take out a new loan to pay off your auto loan (or lease), whether at a lower interest rate or for a longer time period.
- Mortgage Debt Refinancing: When you take out a new loan to pay off your mortgage, whether at a lower interest rate or for a longer time period.
- Stockholder Debt Refinancing: When you use the money in your stock account to purchase additional stocks and then you receive dividends from the initial stocks so that you don’t have to refinance the initial ones.
- Home Equity Loans and Lines of Credit: In the case of a home, people may choose to refinance with what is known as a home equity loan or line of credit. See more on this below.
How does equity work when refinancing?
Equity is the difference between how much your house is worth and how much you owe on it. For example, if you bought a house for $100,000 and sold it for $150,000 (after having paid the down payment), then you’d have $50,000 in equity. If you refinanced or took out an equity loan, you’d now owe that money back if you sold the house for $100,000.
When refinancing your mortgage, most lenders will require any equity to be paid in cash upfront. If you have little or no equity in your home, it might not make sense to refinance at all.
How does debt refinancing work?
The debt refinancing process begins when someone takes out a new loan, usually in order to pay off old debts. The person who is taking out the loans is called the borrower. After an interest rate is agreed upon by both the borrower and the lender, the loan is taken out. This might happen through a bank or through another company that specializes in loans.
The new loan does not have to be for the same amount as what was owed on the old debts. It could be more or less than before, depending on what kind of refinancing is being done (credit card refinancing or mortgage debt refinancing).
Debt refinancing is a process in which people who are having trouble paying off their debt take out a new loan for a longer time period and with lower interest rates. It works by taking out new loans that will allow someone to pay off old debts and/or take out new debts because they are taking up too much of their income. For example, someone with credit card debt might take out a home equity loan at a lower interest rate to pay off the credit card debt.
How does refinancing a debt help?
Debt refinancing allows people with high-interest rate debts to consolidate their debts under one lower-interest-rate loan. By doing this, they are able to save money over time because interest rates are always changing. Someone who refinances their credit card debt, for example, might save hundreds of dollars each month.
Benefits of refinancing debts
- Debt refinancing can be of benefit in some cases when it allows you to access the equity (value) in your home.
- Refinancing a loan allows you to save money by getting a lower interest rate on the new loan.
- Another benefit of debt refinancing is that it helps if you are having financial problems and need an extension on your original loan.
- The debt refinancing process often involves consolidating debt from several different credit cards into a single, larger loan with a lower interest rate. This lowers your monthly payment and can save you money over the life of the new loan.
Disadvantages of refinancing
- Debt refinance is not suggested for people with less than perfect credit since they may have difficulty finding lenders who would agree to it.
- It does not reduce the amount owed on the old debt.
- Debt refinance is not the same as debt consolidation, which reduces your interest rate by combining all of your loans into one new loan with a lower principal balance and new terms. Debt refinance occurs when you replace an existing loan with a new loan without reducing the amount owed on the original one. Debt refinancing allows you to reduce the interest cost if interest rates have declined since taking out your initial loan. Debt refinancing does not reduce the amount owed on the old debt.
- When refinancing a loan, the borrower will often pay a fee for this service.
Why you should not refinance
- People should not refinance because it is adding more debt to their credit cards.
- It is not good for people with bad credit and they will most likely end up taking on more debt than what they started out with.
- People who were in debt can find themselves even more indebted due to debt refinancing. They may have lower interest rates but that can still mean a higher payment. So it is not an ideal option for those with bad credit or low income.
- People should not refinance because if they have been paying their bills on time, creditors will see that as a sign of responsibility and may lower the interest rates without asking them. It is better to wait for this to happen rather than take on the risk of refinancing and starting a new balance.
- One should not refinance debt from one credit card to another unless it is an emergency or one of the cards have a much higher APR than the rest. This will only increase their debts and they could end up in more trouble.
- People who are in debt with multiple cards, sometimes feel that they should switch cards to get a lower APR. This only means that they will end up paying more since they are adding another card onto their balance. It is better if they pay off the cards with the highest interest rate first and then transfer to a new one.
Debt refinancing examples
- The government can also refinance its debts. For example, debt refinancing occurs when the U.S. government borrows money to pay off the interest of the current national debt. The opposite of this is paying down your debt. The U.S. has, in recent years, borrowed money to fund deficits and pay the interest on its enormous debt which began during Reaganomics in 1980-1981 through George Bush Jr.’s presidency.
- Another example of debt refinancing occurs when a company takes out a large loan, then finds that the interest rate charged is high. Rather than continue to pay off its loans at such high rates, it will refinance with a loan that has lower interest by taking out another loan to cover the first one.
- A personal example of refinancing debt occurs when people decide to take advantage of low mortgage rates. Rather than having to make large monthly payments on a high mortgage rate, they can choose to refinance. This allows them to take out another loan with the same amount of money as their existing mortgage, but at a lower interest rate.
- Another example of debt refinancing is someone with a credit card debt might take out a home equity loan at a lower interest rate to pay off the credit card debt. Take forinstance, Joe has three credit cards and two car loans. He doesn’t think he will be able to pay off his debts with his income. He takes out a home equity loan (a second mortgage). Now, instead of having three credit cards and two car loans, Joe has one credit card, one car loan and the home equity loan. Instead of paying $1,000 per month on each credit card ($1,000 is the minimum payment on each of them), he now pays $600 per month on his home equity loan and $400 per month for each credit card.
Debt refinancing can be used for credit cards, mortgages, and business loans.
What are the risks associated with debt refinancing?
The most significant risk with debt refinancing is falling into further debt when taking out new loans. Consulting with financial advisors before pursuing any method of debt relief is encouraged.
What is the difference between refinancing and restructuring?
The main difference between refinancing and restructuring is the effect they have on your credit score and monthly bills. Refinancing can actually increase a borrower’s credit score because it means paying off several smaller debts in favor of one larger debt. It also lowers monthly payments. Debt restructuring, however, usually causes a borrower’s credit score to fall; in most cases, it results in higher monthly payments.
What is better, debt refinancing or consolidation?
Generally, debt refinancing is often better than debt consolidation because it usually results in lower monthly payments, smaller interest rates, and less time spent paying off the credit cards bills.
Dr. Brown is the founder of Jotscroll, he is a Medical Doctor, Entrepreneur, and author. Dr. Razi Brown holds a medical degree from the University of San Diego. He has invested in many startups and is currently working on his fifth book to be published in the upcoming year.