What exactly does refinancing mean?

When you have a number of loans, finding a deal that lands you a lower interest rate can save you a lot of money. Refinancing refers to replacing one of your ongoing debts with a new loan, offering better and more convenient terms. For instance, you may land a deal that offers you a lower interest rate than the previous one.

Debt refinancing is very similar to debt consolidation, but what marks the key difference is the fact that you can only refinance one loan. In the case of debt consolidation, however, people can choose to consolidate multiple loans and commit the one final debt that they owe.

When should you refinance?

The most important motivation to resort to refinancing is usually a chance to get a deal offering lower interest rates. But there are a bunch of other reasons why you may consider refinancing:

1. You want to reduce your monthly repayments:

If you want to pay less each month, you can refinance your loan to one that offers an extended tenure for your loan. Once your application gets approved, you can repay your existing debt with the new one, and eventually pay less each month on the new loan. However, know that the longer your repayment period is, the more interest you will have to pay towards the entire loan.

2. You want to free the guarantor of the ongoing loan:

This option is subject to the conditions defined by your lender. Sometimes, you may want to take a guarantor off your existing debt, simply because of circumstances. In such cases, refinancing your loan with a lender that allows you to remove the guarantor, can be a good option. However, you may want to go through the fine print thoroughly, before taking this step, to avoid any extra charges.

3. You wish to decrease your repayment period:

Refinancing can help you get your hands on a deal that offered better terms, and one of those terms is a shorter loan tenure. Although, decreasing the duration of your loan will imply that you’ll have to pay more towards monthly instalments.

4. Your credit score has progressed:

Your credit score improves when you become more financially responsible. If you have been making timely repayments towards all your ongoing loans, chances are that your credit score would have improved greatly. This will open doors to new and better loan offers that could ease your repayment burden.

5. You need some more money:

You may qualify for topping up your loan if you need some extra cash at hand. If you need a top-up, you can refinance your existing loan for the remaining balance and add the amount that you require. Now you’ll have to pay towards the new loan, wherein you may have a different loan term and interest rate.

Why refinancing is a bad idea?

This is when refinancing is not the best idea:

  1. You may have to pay an overhead charge: Having a thorough run-through of your contract will help you understand the extra costs involved in refinancing. Your lender might charge you an origination fee, which will defeat the whole purpose of saving money through refinancing.
  1. You may end up paying more in interest: Refinancing requires you to end your existing debt by paying it off in full. This may lead to a prepayment charge. So gauge your options before entering into a refinancing loan contract.
  1. Your lender might levy a prepayment charge: When you refinance your loan to get an extended tenure on the new loan, it affects your overall payment towards that loan. As your loan term increases, so does the money you pay towards your loan as you end up paying more interest over time. Refinancing may still be your go-to if you’re looking to reduce the amount on monthly payments. But know that you might end up paying more in the long run.

Does refinancing hurt credit?

Refinancing can jeopardize your credit score in some of the following ways:

1. Undergoing credit check:

When you apply to refinance a loan, lenders perform a hard credit check on you. This can cause your credit score to drop a little. However, the damage is not very significant and it picks up quickly, as you make timely repayments towards your loan.

2. Filing multiple loan applications:

Your motivation to refinance a loan is to find better deals on the table, for which, you’ll have to file an application with more lenders. And when all those lenders will assess your profile and perform a credit check, it will cause damage to your credit score. To mitigate the damage, we suggest you submit your applications carefully, as scoring models can treat credit check performed within 14-45 days as a single inquiry. A lower number of enquiries will mean less damage to your credit score.

3. Closing an existing account:

When you refinance a loan, you terminate your ongoing debt. This would lead to the closure of a long-standing credit account, meaning more damage to your credit score. That being said, if your former account was closed in ‘positive’ or ‘good’ standing, there’s a fair chance scoring models will take that into consideration.