Loans are a highly popular way to gain access to funds. They allow you to bridge gaps in finances and help you comfortably meet fund requirements. However, loans could potentially become unfavourable over time, especially if there are major economic shifts. Fortunately for borrowers, loan refinance is one of the many facilities they could use to make unfavourable loans more favourable.
But then, what is refinancing? In this article, we will explore the concept in detail, understand the various types of loan refinance, and check out the various advantages and disadvantages of this particular facility.
What is Loan Refinance?
Loan refinance is a process where an existing loan is replaced with a new one, often with more favourable terms. A borrower opting for refinancing essentially takes out a new loan to pay off the old one and then proceeds to make repayments on the new loan.
The primary objective of loan refinance is to obtain better loan conditions that align more closely with the borrower’s current financial situation or goals. The improved loan terms can be in the form of reduced interest rates, shorter or longer loan tenures, reduced monthly payments, or a switch from fixed to variable interest rates and vice versa.
One of the many advantages of this facility is that it is available for all kinds of loans, ranging from home loans and auto loans to student loans and even personal loans.
Types of Refinancing
Now that you are aware of what refinancing in banking is let us look at various types of refinancing commonly available to borrowers.
-
Rate-and-Term Refinancing
Rate-and-term refinancing involves opting for a better interest rate, a shorter or longer loan term, or both. Unlike other methods, the principal loan amount does not increase or decrease when borrowers opt for this type of refinancing. Rate-and-term refinancing is ideal for situations where the interest rates have dropped significantly since it allows borrowers to either shorten the loan tenure or reduce their financial outlay.
-
Consolidation Refinancing
Consolidation refinancing involves combining multiple loans into a single new loan. Borrowers often use this to reduce high-interest debt like those from credit cards or if they have taken out many small loans. The objective of this loan refinance method is to simplify debt management and potentially secure a lower overall interest rate.
-
Cash-In Refinancing
Cash-in refinancing involves making a lump sum payment when refinancing to reduce the outstanding loan balance. This often leads to a shorter term, lower monthly payments, or both. Borrowers usually consider opting for this type of refinancing when they have access to a lump sum amount. Here is an example to help you understand how this works.
Imagine you have a personal loan with an outstanding balance of ₹1,50,000. Since you have a lump sum amount of ₹50,000 lying idle in your bank account, refinancing the personal loan using the cash-in method seems viable. You use the ₹50,000 in your account to pay down your outstanding loan balance to ₹1,00,000. Then, you take out a new loan to cover the remaining balance.
-
Cash-Out Refinancing
In a cash-out loan refinance, borrowers take out a new loan for an amount higher than the outstanding balance of their old loan. The remaining funds from the new loan are then taken out as cash to meet other expenses the borrowers may have. Here is an example to help you understand how this works.
For example, assume you have a personal loan with an outstanding balance of ₹2,50,000. You decide to refinance your personal loan by choosing the cash-out option. You take out a new loan of ₹3,20,000 at more favourable terms and use it to pay off your old outstanding loan balance. Then, you keep the remaining funds of ₹70,000 with you as cash to meet your upcoming vacation expenses.
-
Streamline Refinancing
Streamline refinancing allows borrowers to refinance existing loans with minimal paperwork and often without a new appraisal or credit check. This particular loan refinance method significantly cuts down on the time taken to process the refinancing request.
Read More About What is Instant Loan?
Step-By-Step Guide on How To Refinance a Loan
As a borrower, it is not enough to merely know what loan refinance is. In fact, you must also be aware of the process in general. Here is a comprehensive guide that can help you learn how to refinance an existing loan.
- Step 1: Assess Your Financial Situation
Before you think about refinancing a personal loan or any other type of loan, you must first thoroughly assess your financial health, income, and expenses to determine whether you can afford the refinanced loan.
- Step 2: Define Your Goals
The next step is to clearly outline what you hope to achieve through refinancing. Your objective could be to lower your monthly payments, shorten the loan term, or gain access to some cash.
- Step 3: Check Your Credit Score
Your credit score plays a crucial role in determining whether you qualify for a loan refinance. Additionally, it is used to decide the interest rates for which you are eligible. A high credit score of 700 and above is often considered the benchmark for qualifying for better terms.
- Step 4: Research Current Market Rates
The next step is to research current interest rates and compare them with your existing loan to see if refinancing could be beneficial. Refinancing may not be ideal if there is only a minor drop of 25 or 50 basis points. However, if the interest rates in the market are lower by 1% or more, a loan refinance could help you significantly cut down on interest payments.
- Step 5: Compare Different Offers
Apart from looking for refinancing offers from your existing lender, it is advisable to also reach out to multiple other lending institutions to get quotes. This will help you make well-informed decisions.
- Step 7: Apply for Refinancing
Once you have shortlisted the lending institution with the most favourable terms, make an application for refinancing. You may be asked to submit documents such as pay slips, tax returns, bank statements, and information about your current loan and other debts.
- Step 8: Review Loan Estimates
Upon receiving a loan estimate from the lender, carefully compare it with your current loan terms to ensure the terms are favourable. Pay attention to interest rates, tenure, processing charges, and other fees associated with refinancing.
- Step 9: Complete the Process
Once you are satisfied with the new loan terms, sign the paperwork and complete the process. Use the funds from the new loan to settle your debt obligations immediately.
Advantages of Refinancing
Refinancing a personal loan or any other loan, for that matter, can be advantageous. Let us look at some of the key benefits of loan refinance.
- Refinancing allows you to secure a rate of interest that is lower than that of your current loan, enabling you to reduce your overall cost of borrowing.
- Refinancing to a shorter term can help you pay off your loan faster and save on the total interest paid over the life of the loan. However, this would usually lead to higher monthly payments.
- Consolidating multiple high-interest debts into a single, lower-interest loan can simplify your finances and potentially lower your interest burden.
- Refinancing allows you to switch from a variable-rate loan to a fixed-rate loan or vice versa.
Conclusion
Loan refinance can be a powerful financial tool when used responsibly. It allows borrowers to save on interest costs, improve their finances, and manage their debt more effectively. However, before deciding to refinance, you must carefully consider factors such as your financial situation, long-term objectives, and the current economic environment. Additionally, remember to calculate the total cost of refinancing as opposed to the potential savings you would get to enjoy. This will help you decide whether you should refinance your loan or not.
FAQs
How often can I refinance a personal loan?
Generally, there is no limit to the number of times you can refinance a loan. However, some lenders may impose waiting periods for refinancing loans. In such cases, you can only opt for the facility after the expiry of the said waiting period.
Do I need a high credit score to be eligible for loan refinance?
Ideally, yes. Having a high credit score is advisable if you plan to opt for a loan refinance since it will help you secure better and more attractive loan terms.
Should I get my personal loan refinanced?
You can consider refinancing a personal loan if it leads to lower interest rates or better loan terms. That said, it is important to do an extensive cost-benefit analysis by comparing the cost savings with the various fees associated with refinancing.
Is it possible to refinance a loan from another bank?
Yes. Loan refinancing need not always be done with the same bank with which you have your existing loan. You can also refinance your loan with another bank, provided they offer better loan terms.
Will refinancing lower my credit score?
Lenders often do a hard inquiry when you opt for a loan refinance. This could lower your credit score temporarily. However, you can improve your score by making full repayments on time.
