What is Refinancing? How does it Work?

Refinancing debt, also known as refi is the process of repaying one or multiple debts with a new finance facility. A borrower may choose to refinance their debts for many reasons, including reducing their interest rate, changing their payment schedule or simply consolidating multiple payments into one.

The refinancing of debts is very common, with borrowers often choosing to take this route to secure a better deal. Often, this takes place through a refinance onto a personal loan or secured loan, and even a remortgage.

What is the definition of Refinance?             

Refinance is the process of raising finance to repay existing finance agreements. The term was first coined in 1901 as the process of refinancing became more common. During the refinance process, the interest rate, payment schedule and other terms are revised, and a new finance agreement is signed by the borrower.

For example, a borrower with a £2,000 overdraft and credit card balance of £6,000 split across 3 cards could refinance to a personal loan of £8,000. In this case, the borrower may reduce their interest rate and would be moving from revolving credit onto a defined repayment schedule with set monthly payments.

Does a Refinancing Loan differ from the concept of Refi?

No, refinancing and refi are terms that are used interchangeably. Refi is simply short for refinancing.

How does refinancing work for loans?

Refinancing is an umbrella term that is used to describe the repayment of one debt with another. In practice, there are several different types of refinancing including personal loan refinancing, remortgages and secured loans.

What are the types of refinance?

There are four main types of refinance, they are rate-and-term refinancing, cash-out refinancing, cash-in refinancing and consolidation refinancing.

1. Rate-and-term Refinancing

Rate and term refinancing involves making a change to the interest rate or term of your loan while making no change to the loan balance. The aim of this is to reduce the interest rate or to extend or reduce the time taken to repay the loan. For example, a borrower has a loan of £10,000 at an interest rate of 11.9% per annum with 3 years remaining on the term. By refinancing to a loan of £10,000 over 3 years with a reduced interest rate of 7.9%, the borrower could save £462.97 in interest over the loan term.

2. Cash-out Refinancing

Cash-out refinancing, also known as a refinance with capital raise, as the name suggests involves refinancing while taking out a larger loan than the ones you’re repaying. When capital raising, the additional funds are released to the borrower, to spend as they wish.

Using this method of refinancing will usually increase your finance costs unless you extend the loan over a longer term.                      

3. Cash-in Refinancing

Cash-in refinancing involves refinancing debts while reducing the loan balance through cash input from yourself to cover the shortfall. This approach will reduce your balance and therefore the amount of interest that you’ll pay. Cash-in refinancing is an excellent option for those looking to reduce their interest costs and may lead to you getting a better deal.              

4. Consolidation Refinancing

Consolidating refinancing, or debt consolidation refinancing involves refinancing multiple debts into one simple monthly payment. This approach is often used by borrowers who are looking to simplify their finance after struggling to keep track of multiple payments to multiple lenders. Consolidation refinancing can result in lower interest payments depending on the type of debts refinanced and the terms of the new finance facility.                           

When should I Refinance a Loan?

When looking to refinance debts onto a new loan or remortgage, timing is key. The simple answer is to consider debt refinancing when something changes, such as market conditions improving, your credit history improving or if you begin to struggle with repayments.

Any one of these factors may be a sign that it’s time to consider refinancing, but even if nothing changes, it’s worth testing the market at least every 6 months. It could lead to you securing a better deal.

Which Loan Type is Better for Refinancing?

Refinancing can be beneficial for all kinds of borrowers and using almost all loan types, including personal loans, car loans, secured loans and remortgages.

What are the advantages of refinancing?

Refinancing your loan can have a number of benefits including reducing your loan term, reducing your interest rate and simplifying your finances.

1. Shorten your Loan’s Term

When securing a better deal on your borrowing, reducing your loan term can alter your payment schedule and will result in your paying off your loan sooner. This has the added benefit of reducing your total interest costs, compared with paying back over a longer term.

2. Consolidate Debt

Using debt consolidation to combine multiple debts into one simple monthly payment can make it much easier to manage your monthly outgoings. Many borrowers who have multiple debt repayments per month find it difficult to track which payments have been made and which will fall due later in the month. This can make it difficult to manage how much money they can spend each month without missing their loan repayments.

3. Secure Lower Interest Rate

Refinancing debts can lead to you securing a lower interest rate, saving you money on your debts. You may be eligible for a better deal if either your credit history or market conditions have improved since you originally borrowed the money.

When is refinancing better for investors?

Property investors may choose to refinance debts to release the funds required for further investment. For example, a landlord may release funds from his multi-let property using an HMO mortgage to release equity which is then used as a deposit on another HMO. This would allow the applicant to increase his income through the acquisition of more income-producing assets.            

Is refinancing worth it?

Yes, refinancing can greatly improve your financial position. Of course, the biggest benefit will be achieved for borrowers with unsuitable loan terms or high-interest rates. That said, regular financial reviews should be considered by everyone and as an absolute minimum will give you peace of mind that you have the best deal. At best, they could transform your finances.