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How Refinancing Works: Pros and Cons of Replacing a Loan

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When you are looking into getting a loan, these days you will hear a LOT about refinancing loans for major purchases. In the simplest terms, the term “re-finance” means to finance a loan again under new or different obligations.

The reason why refinancing has become such a popular topic is because the benefits it can carry are extremely attractive; your refinanced loan could have a better interest rate, or an adjusted repayment period that works better for your current lifestyle than your original loan terms.

Essentially it gives you a new lease on your loan which can be great, especially if your current loan conditions are not working out the way you originally planned.

However, it’s important to note that merely because refinancing is a good idea for one person does not mean that it’s right for everyone, nor is it right for every situation. Refinancing terms and conditions can very GREATLY by country, province and state alone! Let’s take a closer look at refinancing, it’s benefits, and it’s cons.

When to Refinance

So if it’s not right for every one at every time, when do people usually refinance? There are many instances in which refinancing your loan can be attractive.

  1. To take advantage of a lower interest rate.
  2. To reduce the monthly payment for the loan. This is usually done by extending the repayment term, resulting in lower payments per month.
  3. To alter or reduce risk in the instance of changing from a variable to a fixed-rate interest rate. 4. To have more disposable income on a monthly basis. If the loan term is extended and the loan payments are lower each month, then the borrower will have more money to “play with” each month.

As you can see most of these options result in the borrower having less money to pay on their loans each month, whether it be in their payment or in their interest rate. These changes to the loan conditions can seem great, but you need to

seriously evaluate your financial situation before you decide if refinancing is right for you.

Watch your loan carefully.

Has the interest rate gone down? If so, then it may be a good time for you to consider refinancing.

A decrease in interest is one good reason to refinance but you may also have too many loans on your plate at the moment, too. Refinancing your loan can allow you to consolidate several loans into ONE, with a single monthly payment instead of one for each loan. This can be extremely persuasive for people with debt in several different channels (mortgage, car, credit card), as students who may have several student loans from the same company.

Why to Refinance

We have seen that refinancing can be attractive, but why? Refinancing options are typically chosen in order to make the borrower’s life easier. It can even help you save money in the long term, allowing you to free up more money each month to put into your savings account.

When refinancing, borrowers consider their current financial situation and repayment abilities and compare them to their original loan.

It is worth saying that, unfortunately, things do not always work out the way we initially plan. Say for example that you just got a good job with a salary of about $45,000 per year, and you have about $5,000 in your savings account. You decide to take out a mortgage, thinking that with the new job you will be able to put $500 toward the mortgage each month and pay it off in 20 years. Unfortunately, soon after you are hired your company goes bankrupt and you lose your job without warning.

The $5,000 in your savings account won’t cover your living expenses AND your mortgage until you find another job, which could take months.

How can you pay back your mortgage now? The above example is a prime condition for refinancing. Sometimes, “life happens” and we are faced with things we cannot always predict. In the example above, refinancing could help you get a lower interest rate, or extend your mortgage to perhaps 30 years. However, you must carefully consider precisely what you’re getting yourself into.

If you extend the mortgage but cannot get a lower interest rate

at the same time, you will end up paying MORE in interest at the end of the new 30-year loan term. But because your current unemployment conditions leave you unable to pay $500 every month, a longer term with the same interest will work better for you than starving in an empty home!

Be sure to look at both sides of the coin. Consider your current financial situation and your possible immediate-future before diving into the decision to refinance any loan, no matter how attractive it may seem!

How to Refinance

Refinancing can seem just as intimidating as getting a loan in the first place! But with careful research, the task can be much less daunting. The first thing you need to do when refinancing a loan is to check the payoff. Will refinancing reduce your debt, leave it unchanged, or increase it? If the answer is “unchanged” or “increase”, it might not be right for you to refinance. After checking the payoff, shop around.

That’s right; much like when you apply for a loan, you have to do research for refinancing as well. Try not to discount your original lender — while you may not be happy with your current loan conditions, there’s a good chance you may not find a better rate.

When refinancing, you also may want to consider discussing your refinancing plans with a financial expert such as a broker. Brokers are experienced financial professionals who may be able to give you more information, and information that suits your situation more personally than the customer service representatives at a traditional lender.

Please note: in some cases your existing loan has fines if you want to change them or refinance.

You must check carefully whether you have fine or not. If yes, you have to add fine amount to calculation when you check the Profitability for the refinance. When you’re looking to refinance, remember not to do ANYTHING based solely on hearsay!

Take a careful, close look at your personal financial situation and YOUR repayment abilities and keep in mind that your situation will vary greatly between you and those of your friends.

Be sure that refinancing will reduce your debt, not add to it. Compare offers from many different lenders before you decide on the one that is best for YOU.

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Stephen Rhodes

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