What Is a Refinance?

A refinance occurs when an individual or business revises the interest rate, payment schedule, and terms of a previous credit agreement. Debtors will often choose to refinance a loan agreement when the interest rate environment has substantially changed, causing potential savings on debt payments from a new agreement.

How Refinancing Works

A refinance involves the reevaluation of a person or business's credit terms and credit status. Consumer loans typically considered for refinancing include mortgage loans, car loans, and student loans.

Business investors may also seek to refinance mortgage loans on commercial properties. Many business investors will also evaluate their corporate balance sheets for business loans issued by creditors that could benefit from lower market rates or an improved credit profile.

Refinancing occurs when a person or business changes the interest rate, payback schedule, and terms of an already existent agreement

Understanding Refinance

The current rate environment is typically a key catalyst for loan refinancing. Other factors that trigger a refinance can be an improved credit profile or a change in long-term financial plans.

Key Takeaways

  • A refinance occurs when a previous loan has been revised in terms of the interest rate, payment schedule, and terms.
  • A refinance involves the reevaluation of a person or business's credit terms and credit status.
  • Consumer loans often considered for refinancing include mortgage loans, car loans, and student loans.

A common goal is to pay less interest over the life of the loan. Borrowers may also want to change the duration of the loan or switch from a fixed-rate to an adjustable-rate mortgage, or vice versa.

Types of Refinance Loans

There are several different types of refinancing options. The type of loan a borrower decides on depends on the needs of the borrower.

Rate-and-term refinancing

The most common type of refinancing is called the rate-and-term. This occurs when the original loan is paid and replaced with a new loan requiring lower interest payments.

Cash-out refinancing

Cash-outs are common when the underlying asset collateralizing the loan increases in value. The transaction involves withdrawing the value or equity in the asset in exchange for a higher loan amount.

In other words, when an asset increases in value on paper, you can gain access to that value with a loan rather than by selling it. This option increases the total loan amount but gives the borrower access to cash immediately while still maintaining ownership of the asset.

Cash-in refinancing

The cash-in refinance allows the borrower to pay down some portion of the loan for a lower loan-to-value ratio or smaller loan payments.

Consolidation refinancing

In some cases, a consolidation loan may be an effective way to refinance. A consolidation refinancing can be used when an investor obtains a single loan at a rate that is lower than their current average interest rate across several credit products.

This type of refinancing requires the consumer or business to apply for a new loan at a lower rate and then pay off existing debt with the new loan, leaving their total outstanding principal with substantially lower interest rate payments.

Special Considerations for Refinance

Interest rate environments are cyclical and as such are followed closely by consumers and businesses for new credit as well as credit refinancing. National monetary policy, economic cycle, and market competition can be key factors causing interest rates to increase or decrease for consumers and businesses.

During economic valleys, interest rates may be lowered to help stimulate consumer spending and business investment. Economies in an expansion will typically see interest rates rising as the economy improves.

These factors can influence interest rates across all types of credit products including both non-revolving loans and revolving credit cards. In a rising rate environment debtors with floating-interest-rate products can expect to see their interest rates automatically increased and vice versa with a decreasing rate environment.