At times in life, people often need to broaden their financial options, be it due to an unexpected bill, a new member of the family, or extra purchases. When this happens, it is common to seek a loan from a variety of different sources. While at the time of purchasing a loan, the interest rate and borrowing costs may be suitable, new products may offer better terms.
Ultimately, this is why many individuals who have purchased loans in the past are choosing to look for refinancing agreements. The important question is, what does loan refinancing actually mean?
What is loan refinancing?
When any loan agreement is entered into, terms are signed to protect both the borrower and the provider. However, sometimes circumstances occur where said terms are no longer the best possible option for the borrower. The right option may, therefore, be to look at options to use another provider (or even the same provider) to change the terms of the loan.
This is essentially borrowing the same or a different amount of money in order to pay off the current loan and take out a new one. Basically, the terms of the existing loan (be it the repayment period, interest rate, or terms of another nature) are modified, and a new agreement is taken out.
Why refinance?
There are many reasons you may consider refinancing your current loan. Ultimately, the aim is to ensure you have the beste deal. Loans are generally longer-term commitments (typically between 1 and 5 years), and so the terms initially taken at the start of the loan may not be the beste available later in the repayment period.
Some providers offer simple refinancing options, while switching to new providers may be more suitable in some cases. Some of the factors to consider when looking to refinance your loan are interest rates, repayment schedules, and the overall cost of borrowing.
What options are available?
There are four main types of loan refinancing available in the market: rate-and-term refinancing, cash-out refinancing, cash-in refinancing, and consolidation refinancing. As the name suggests, rate-and-term refinancing is essentially paying the original loan and taking out a new one with a new rate and term.
Cash-out refinancing is the process of withdrawing the equity built through an asset that has acted as collateral in the original agreement. This commonly occurs when said asset has increased in value. Cash-in refinancing allows the borrower to pay extra towards the value of the original loan in exchange for smaller payments. Finally, consolidation refinancing is the process in which multiple loans or finance agreements are bundled together for a single agreement.
What costs are involved?
There are multiple potential sources of costs when choosing to refinance a loan agreement that you should be aware of. In most cases, if you choose to leave your current provider for another provider, there will normally be a clause that charges a termination fee within a certain period of the original agreement.
There may also be administration fees involved, as well as broker fees if one is used during the process. Depending on the type of loan, a mortgage for instance, there may also be taxes and other fees to pay. Before proceeding with any loan refinancing agreement, it is crucial to understand the true cost of refinancing.
How to approach loan refinancing
Quite simply, the best approach is to shop around for the best deal. You should also ensure you understand the implications imposed by your current lender. You should begin by reviewing your current contractual loan agreement to ascertain any break clauses or exit fees.
Before choosing a lender, review the current offerings in the market and understand where the beste deal will come from. On the surface, introductory refinancing rates may appear attractive. Still, it is common to have a short-term interest rate on new deals, with potential steep increases after a defined period.
For example, a new loan may have a low interest rate for a fixed term of two years before increasing substantially if not repaid in full.
Is now the right time to refinance?
Global interest rates have risen sharply since the pandemic began in 2020. They are now beginning to fall again, but if your original agreement was undertaken prior to 2020, you may find that the interest rates encountered when looking to refinance in 2024 are actually higher than your original.
That being said, banks are beginning to lower interest rates, and we are seeing a fresh wave of lower-interest borrowing. In essence, the best idea is to shop around to ensure you understand the implications of refinancing your loan before committing to any new agreements.
Interest rates may fall further over the coming months, but they may also rise again. This is ultimately an unknown factor when deciding whether to refinance your current loan agreement right now.
Product Types
Financial lending has been in existence for as long as we have used money. Over the years, though, financial lending has evolved substantially from providing physical collateral to written agreements.
Collateral loans are still common, with companies offering the chance to use things like property as a guarantee that the financial sum will be repaid. Unless you are completely certain your spending power will allow you to make the requisite repayments, it is advisable to approach collateral lending with extreme caution.
Some common finance agreements are mortgages (lending to purchase a property), secured loans (collateral as security to guarantee repayment), unsecured loans (a finance agreement whereby no collateral is used to secure the sum), and credit cards (the ability to purchase items on a card that has a monthly repayment amount).
All of the above items can be refinanced into a new agreement if applicable and permitted.
What can you purchase with finance agreements?
In short, the answer is almost anything. Mortgages are specific to property buying, but loans can be used to purchase almost anything within the realms of the law. For example, a loan can be undertaken to purchase a car, invest in a business, or to purchase items like laptops and mobile phones.
It is becoming more common for mobile phone providers to split monthly contracts into 2: an agreement for the line rental and a separate loan for handset costs.
Credit cards can be used to purchase a myriad of items. It is becoming more common for individuals to use credit cards for their monthly expenses and pay the balance at the end of the month when the card is used. As long as this is undertaken in a controlled manner, it can have multiple benefits, including building credit scores.
Choosing the right company to work with
Interest rates, lender reputation, and loan terms are three of the most crucial factors to understand when refinancing a loan. You may choose to stay with your current lender for a consolidation loan or may choose to look elsewhere for it and any other type of refinancing agreement.
There are many comparison websites and search engines that you could use to find the right lender for you. If the loan is for a substantial amount, it may also be a good idea to consider the use of a broker when refinancing your current loan agreement.
There is no formula for choosing the correct company to handle your refinancing agreement, but you should always take your time to ensure you are making the right choice. Affordability and potential repercussions for missed payments should always be carefully considered.
Eligibility criteria
Depending on the original loan finance agreement and contract undertaken, the eligibility criteria for a refinancing agreement can be relatively stringent. Some lenders specify a no-break period, meaning refinancing costs may be higher. Others specify that after a period of time, refinancing costs may be lower.
Above all, the eligibility criteria normally come down to credit rating. If your credit rating is stronger, you may find it easier to refinance. Some lenders offer credit-boosting products like top-up credit cards that allow you to stay in control of your spending without entering into unnecessary debt.
Such credit cards work in a way that allows you to load cash from your debit account into the credit account before spending. You should always take the time to analyze the best approach before taking out any more credit or loan agreements.
Next steps
Should you wish to proceed with a refinancing agreement, the first step you should take is to review your current agreement to understand the terms and conditions applicable for refinancing.
Following that, it may be advisable to contact your current lender to understand the exact implications and any possible offers they may be able to give to you. Once you have understood the implications, seeking financial advice from a trained professional is recommended.
Before signing up for any new agreement, you should review your credit file, current outgoings, and affordability. It may be the case that remaining in your current deal is more suitable for you at this moment in time.
