Refinancing replaces an existing loan with a new loan that pays off the debt of the old loan. The new loan should have better terms or features that improve your finances. The details depend on the type of loan and your lender, but the process typically looks like this:
You have an existing loan you would like to improve in some way.
You find a lender with better loan terms, and you apply for the new loan.
The new loan pays off the existing debt completely.
You make payments on the new loan until you pay it off or refinance it.
Refinancing can be time-consuming and expensive, and a new loan might be missing attractive features that an existing loan offers. However, refinancing has several potential benefits
A common reason for refinancing is to save money on interest costs. To do so, you typically need to refinance into a loan with an interest rate that is lower than your existing rate. Especially with long-term loans and large dollar amounts, lowering the interest rate can result in significant savings.
Property price grows over time and your loan amount typically decreases meaning you may have some equity in your home that you can release by refinancing. The released equity can be used purchase another property, other investment or any other worthwhile purchase such as renovation, holiday, purchase car etc.
Refinancing can lead to lower required monthly payments. The result is easier cash flow management and more money available in the budget for other monthly expenses. When you refinance, you often restart the clock and extend the amount of time you’ll take to repay a loan. Since your balance is most likely smaller than your original loan balance and you have more time to repay, the new monthly payment should decrease.
Instead of extending repayment, you also can refinance into a shorter-term loan. For example, you might have a 30-year home loan, and that loan can be refinanced into a 15-year home loan that typically will come with a lower interest rate. Of course, you can also just make extra payments without refinancing to avoid paying closing costs and keep the flexibility of not being required to make those larger payments.
. If you have multiple loans, it might make sense to consolidate them into one single loan, especially if you can get a lower interest rate. It’ll be easier to keep track of payments and loans.
If you have a variable-rate loan, you might prefer to switch to a loan at a fixed rate. A fixed interest rate offers protection if rates are currently low, but expected to rise.
Some loans, particularly balloon loans, have to be repaid on a specific date, but you might not have the funds available for a large lump-sum payment. In those cases, it might make sense to refinance the loan—using a new loan to fund the balloon payment—and take more time to pay off the debt. For example, some business loans are due after just a few years, but they can be refinanced into longer-term debt after the business has established itself and shown a history of making on-time payments.
It is very common in Australia to have a fixed rate term of between 1 to 5 years. When your fixed rate finishes at the end of that 1 to 5 year period (or expires in bank talk) your loan will change back to a variable rate. However in most cases the bank’s standard variable rate doesn’t have any discounts! You can avoid this by switching to another fixed rate, or looking at your refinance options to maximise your interest rate discount.
