Refinancing, or refi as it is abbreviated by some, is the process through which the terms and conditions of an existing credit facility is revised and replaced. This financial procedure has helped to dig a lot of people out of debilitating debts. It is a handy financial product that makes debt reduction/freedom possible.
Most often, when people hear the word refinancing or refinansere according to the Norwegians, all they think about is mortgage. The truth is that refi can be applied to all sorts of loans or credit arrangements/agreements. In this article, we will give a brief explanation of what this entails and how to get it right.
What Is Refinancing and How Does It Work?
We have explained briefly that this is a process through which a debtor replaces an existing loan with one that has more favourable terms and conditions. That is putting it quite simply.
Refinancing Explained
The consumer in this arrangement seeks a credit facility that is more favourable in terms of repayment schedule, the interest rate and other terms compared to what they have presently. Upon approval, the new credit that is extended is used to pay off the existing loan and then the terms and conditions of the new loan takes effect.
One of the major reasons why borrowers seek to refinance loans is usually a change in interest rate. With the change in interest rate, the borrower can make substantial savings from repaying their debts with a new and more favourable credit arrangement.
Other reasons for refi include a reduction in monthly payment, an adjustment in the lifespan of the loan (this can be a reduction or an increase in the duration of repayment) and changing from an adjustable rate loan to a fixed rate.
How It Works
For one to refinance a loan, they will have to approach a bank, financial institution or any other approved lender. They may choose to work with the initial lender or seek out a new firm/company. Upon request the borrower will be given a new application to fill out.
The lender will then evaluate the applicant’s credit status and their financial strength. The re-evaluation will differ based on the type of credit that they want. Most common loans that borrowers seek a refi for are mortgages, student loans and auto loans. Click here for more information on how refinancing works.
How to Refinance Right
In order to get refinancing right, there are a number of things that one should bear in mind. It wouldn’t do for borrower to just take out another loan only to discover that they have moved from frying pan to fire. To this end, we will share 4 things that anyone that wants to refinance should know and do. Note that this isn’t an exhaustive list.
These 4 things are as follows:-
- Know your credit score
- Know your debt to income ratio
- Know the terms and conditions of the existing loan agreement
- Know the pros and cons of refi for your specific circumstance.
Know Your Credit Score
In recent times, banks and financial institutions have raised the bar for credit scores as it affects loans and refinancing. That is why some consumers have met with rude shocks when they applied for refi. People who thought they would get loans with more favourable terms and conditions did not. This is due to the fact that the acceptable credit score for loans with lowest rates is from 760 upwards.
Previously, anyone with a score of 650 was considered as having good credit but nowadays, that’s not the case especially for mortgage refi. To this end, it is necessary that you keep a close eye on your credit history and ensure that it is as high as possible. This will enable you get the lowest rates and best terms and conditions.
While it is true that borrowers with lower scores will get loans, the interest rates will be high and other terms and conditions might not be as favourable as desired.
Know Your Debt to Income Ratio
Debt to income ratio refers to the percentage of one’s monthly income that is used to service debts. While one may need a high income, stable job or proof of profitable enterprise to get a loan, many lenders also consider how much of this income will be available for debt repayment.
Note that one’s income will also be used for household expenditure and other living expenses. That is why many lenders do not joke with debt to income ratio of their applicants. Your DTI as it is commonly called is recommended to be between 36 and 43%. Check out https://en.wikipedia.org/ for more on the subject.
Know the Terms and Conditions of Your Existing Loan
The essence of refinancing is to get a more favourable loan to replace the one on ground. To this end, you need to know to the tiniest detail, the terms and conditions of the existing loan.
Is there a prepayment penalty on the loan you seek to refinance? This penalty is usually put in place by some lenders to help them recoup the loss made on interest when a borrower repays their debt early. If this penalty is in place, you may find that it will diminish whatever advantage you may get from refinancing. So you might as well continue with the existing contract.
Additionally, know exactly how much you pay out monthly, the interest and every cost that make up the total cost of the loan. This will help you determine whether a refi is worth it or not.
Know the Pros and Cons Of Refi for Your Specific Circumstance
You will do well to know and then weigh the pros and cons of taking out a refi loan for your specific circumstance. Here’s a list of some pros and cons for you to consider:-
Pros
- You may get a loan with a lower monthly payment which will make repayment less burdensome for you.
- You can change from a variable interest rate to a fixed interest rate and this will offer you monthly payments that are predictable.
- You can save money on overall interest payment on a loan with shorter repayment duration.
- You can get lower interest rate offers with an improved credit score.
Cons
- Repayment penalty may diminish the value of the refi.
- Longer repayment duration will incur higher interest rate paid in the long term.
- May reduce your credit score due to hard credit inquiry that will be run on your account
Conclusion
Refinancing is not a decision to be taken lightly; you need to take your time, research and then think through before making the decision. We believe the information shared here will go a long way to help you get started in your research to help you make the right decision.
