Basics of Loan Refinancing

If you aren’t satisfied with your loan terms, you might want to consider refinancing it. Essentially, this allows you to replace your current loan with a new one.

By refinancing your loan, you can revise the terms of your loan agreement so that they better suit your needs. For example, you can try to secure a lower interest rate, which can be especially beneficial to those with long-term loans, like a mortgage.

Here’s what you should know about the basics of loan refinancing, including personal loans, to decide whether it makes sense for you.

Definition of loan refinancing

Loan refinancing refers to the process of replacing your existing loan’s terms with a new one. You can take out a fresh loan that has more favorable terms, replacing your old loan.

Loan refinancing also restarts the term of your loan, allowing you to prolong the time you have to repay your debt. If you are running out of time on your current debt repayment schedule, loan refinancing could give you extra time by resetting the clock.

Types of loan refinancing

Mortgage refinancing

One of the most common reasons borrowers refinance a loan is to replace their existing mortgage with better terms.

There are several subtypes of mortgage refinancing. Here is what you might encounter:

Rate and term refinance: Rate and term refinance focuses on changing the interest rate and/or the loan term. The goal is generally to lock in new loan terms that have lower interest rates.

Cash-out refinance: A cash-out refinance enables you to refinance your existing mortgage for an amount that is higher than the remaining balance. The difference between the new amount and your old outstanding balance is then received as cash. Cash-out refinance is similar to obtaining a personal loan in that it gives you funds that you can use for a multitude of purposes.

Streamline refinance: This is a special kind of refinance option that is available to certain government-backed mortgages. If you have a Federal Housing Administration (FHA) loan or a Veterans Affairs (VA) loan, you might qualify for streamline refinancing.

Student loan refinancing

Student loan refinancing allows you to replace your existing federal student loan(s) with a new one from a private lender. Generally, those who want to refinance their student loans are seeking a lower overall interest rate so that they can save money in the long run. Student loans often have very long repayment terms, so a reduced interest rate can grant you significant savings.

When choosing the negotiate the terms of a new student loan agreement through refinancing, you can also try to extend the loan tenure or improve the terms in another way.

The drawback to student loan refinancing is that you would be losing out on federal student loan benefits. Compared to other loans, federal student loans come with special terms, options, and forgiveness programs. By replacing them with a private loan, you would no longer be eligible for federal student loan programs.

If you refinance your student loan, you would potentially:

• No longer be able to qualify for forbearance
• No longer have deferment options
• Forfeit all chances of joining a federal student loan forgiveness program

Because of the various disadvantages to refinancing your federal student loans, it’s advisable to carefully weigh its pros and cons and consider your alternative financial options before making the ultimate decision.

Auto loan refinancing

If you have an active auto loan that you’ve used to finance a vehicle, you can choose to refinance it for better terms. Usually, you would be replacing your existing auto loan with a new loan from a different lender.

By refinancing your auto loan, you can potentially lower the interest rate on your auto loan. This can happen if the average auto loan interest rate has dropped significantly due to shifting market conditions since you originally obtained the loan.

Another reason you might be able to refinance your loan to get better terms is if your credit score has increased. With a higher credit score, you appear more creditworthy to lenders–there is a lower risk associated with lending you money. They might be willing to compromise with you and improve your auto loan terms.

Business loan refinancing

If you are a business owner who has taken out business loans, this option allows you to negotiate better terms. One of the primary reasons to refinance your business loans is to obtain a lower interest rate.

In addition, business loan refinancing can help improve your cash flow. If your business is struggling, refinancing your loans can help you reduce the amount of money you need to pay each month for your loan repayment schedule. Depending on what your new lender’s terms are, you also might be able to access additional funds, which could be key in keeping you afloat.

If you wish to refinance your business loans in order to save money, make sure you review whether there are prepayment or refinancing penalties and fees. Just because your newly negotiated loan has a lower interest rate does not necessarily guarantee that you would be saving money.

Personal loan refinancing

This is a more generic type of refinancing since it allows you to replace your existing personal loan(s) with a new one.

Benefits of loan refinancing

If you can find a good lender who allows you to negotiate your refinancing terms and obtain favorable rates, there are many benefits you can reap from loan refinancing. Here are some of the potential advantages of loan refinancing.

Extended repayment term

If you refinance your loan, you can extend your repayment term. A longer repayment term could help you reduce the amount of money you need to pay each month, since you have more time to pay the same total loan balance.

Reduced interest rate

If you successfully refinance your loan to have a reduced interest rate, you can save a meaningful amount of money in the long run. Lower interest rates mean your monthly payments will cost less, which makes your debt repayment schedule easier to manage.

Loan consolidation

An advantage of loan refinancing is that you can consolidate your debt into a single loan. If you have debt from numerous sources, it can be challenging to keep track of every monthly payment you need to make. Loan consolidation can be a valuable way to simplify your debt.

Risks of loan refinancing

More accrued interest

This is a common risk associated with loan refinancing that borrowers may not be aware of. If you are able to extend your loan term, you will have more time to pay off the loan balance–this means your monthly payment amounts may be reduced.

Fees and penalties

If you refinance a loan and replace it with a new one, it doesn’t mean you are automatically freed of your old contractual obligations. Your old loan agreement might designate certain fees that you will be charged if you refinance a loan.

The two main kinds of fees and penalties for financing a loan are:

Prepayment penalty: Prepayment fees are implemented if you pay off and end a loan early. This may be a flat fee or, more commonly, a percentage of your outstanding loan balance based on how much interest hasn’t been paid. This can end up charging you quite a significant amount, so be careful about prepayment fees.

Application fees: When you refinance a loan, your lender might charge you numerous application fees to make up for processing the loan.

Loan refinancing providers

There are plenty of options available to you depending on which kind of loan(s) you are seeking to refinance. Because of how much impact finding the right lender can have on your financial and living situation, it is critical to find a suitable, legitimate loan refinancing provider who does not use predatory schemes.

Here are a few prominent, reputable refinancing companies out there that you may want to consider.

SoFi

SoFi is an online personal finance company and bank that is based in San Francisco. They offer various loan refinancing services such as for student loans, mortgages, and personal loans. If you expect to use multiple financial and loan services, SoFi offers member benefits that you could leverage for your own needs.

Earnest

If you’re looking for student loan refinancing, mortgage refinancing, or personal loan refinancing, Earnest could be the choice for you. This company is known for helping borrowers find a plan with specific terms that work for them.

LightStream

LightStream is a leading lender known for its competitive rates. If you want to refinance an auto loan, personal loan, or other kind of loan, LightStream is a good option to consider.

If you need immediate funds within a day or two, LightStream may be able to provide you with extremely fast funding after you sign a loan agreement.

Wells Fargo

As one of the largest banks in the US, Wells Fargo offers a wide variety of loan refinancing options, including mortgage refinancing, auto loan refinancing, and personal loan refinancing. With a huge network of branches, it is convenient to apply for loan refinancing at a Wells Fargo branch–so long as you meet the eligibility requirements.

Eligibility criteria

To be eligible for refinancing a loan, there are certain eligibility requirements you need to meet. While exact criteria depend can vary based on what kind of loans you are refinancing and which lender you have chosen, here are some of the common eligibility factors:

Your credit score: The higher your credit score, the more creditworthy (suitable to be given a loan) you are. If you have a credit score above 670, it is easier to qualify for loan refinancing.

Your debt-to-income (DTI) ratio: Regardless of how much money you make, if over 43% of your income goes toward covering your existing debt, your lender may not allow you to refinance your loans.

Loan type: Lenders may have certain kinds of loans they refuse to refinance. For example, a private lender might allow you to refinance personal loans, but not student loans.

Equity: For mortgage refinancing, if you have equity in your property, it can increase your chances of refinancing a loan.

Interest rates

When you refinance a loan, you may be able to reduce the overall interest rate you need to pay. This can help you save money in the long run, particularly in the case where you’re refinancing a mortgage or federal student loan.

Repayment options

Loan refinancing can help you extend the repayment term or negotiate for better repayment terms. Lenders may agree to compromise and grant you better terms, especially if you have a good credit score and recent credit behavior.

Loan refinancing process

The first step of loan refinancing is to evaluate your existing loan(s) to determine whether it is advantageous for you to try and refinance it. It’s a good idea to consider your outstanding loan balance, interest rate, and if there are penalties that come with refinancing the loan.

To apply for a loan refinancing, you need to find prospective lenders. It is advisable to research and shop around to find the lender who might be optimal for your particular needs. For example, if you want to refinance a mortgage, look into who the best mortgage refinancing companies are.

You can apply for a loan refinance online, over the phone, or in person. To submit the application, you may need to submit relevant, accurate documents about yourself and your existing debt.

After that, your lender will assess your loan refinancing application. In the case of mortgage refinancing, the lender might appraise your property before approving you. If everything works out on the lender’s part, they will send you a loan agreement with all the new loan’s terms and conditions.

If you choose to sign the refinancing offer, you’re locked in contractually. Your new lender will work with your previous creditor(s) to settle your existing outstanding balances.

Finally, the refinancing process is complete. You’ll start making monthly payments based on your new loan’s repayment terms.

Fees and charges

Origination fee

The lender might charge an origination fee for processing the new loan when you refinance old loans. This origination fee may be a flat fee or anything from 0.5% to 10% of your new total loan amount.

Prepayment fee

Your original lender might charge you a prepayment fee for paying off your old loan ahead of the loan’s maturity date. Since you are replacing your old loan with a new one during refinancing, you might be obligated to pay a prepayment fee.

You can check your loan agreement to see whether your contract includes a prepayment penalty.

Other refinancing fees

From application fees to other third-party fees, you might incur numerous charges by the end of your loan refinancing process. Here are a few fees you might need to pay:

• Credit report fees
• Attorney fees
• Escrow fees
• Recording fees for mortgage refinancing
• Appraisal fees for mortgage refinancing

About The Author

Ru Chen

Content Writer

Ru Chen is a content writer with several years of experience in creating engaging and well-researched articles. She mostly writes about business, digital marketing, and law. In her free time, she can be found watching horror movies and playing board games with her partner in Brooklyn.

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