By Essie Bester
With interest rates at their lowest in a long time many people are wondering whether they should jump at the opportunity to refinance their bond. You can refinance a homeloan, car loan or just about any other type of debt. It could be an excellent opportunity to lower your monthly payments and could open the way for you to pay off your bond debt faster.
However, financial practitioners caution that there are many factors to consider before you sign on the dotted line.
What does refinancing really comprise and what are your options?
- Refinancing involves reviewing the terms of an individual’s or business’s existing credit agreements (e.g. a loan or bond) as well as their financial situation with a view to first paying off the first loan and replacing it with a new loan. The credit and repayment status of a person or business is therefore being reevaluated.
- In reality refinancing tries to favourably change interest rates, payment schedules and other terms of a contract. Borrowers are inclined to refinance when interest rates drop. If it is approved, the borrower gets a new contract that replaces the original agreement.
- You pay the same closing costs that you paid when taking out the first loan and this could be high depending on how big your new loan is.
- In order to refinance, a borrower has to approach his current credit provider with the request and complete a new loan application. The new loan will pay off your existing loan in full and in one instalment as soon as your loan for refinancing is approved and you have completed the closing process.
- Consumer loans regularly considered for refinancing include mortgage loans, car loans and study loans.
Types of refinancing
The type of loan the borrower decides on depends on the borrower’s needs. Some of these refinancing options include the following:
Refinancing of rate-and-term loans to cut monthly costs: This is the most common type and takes place when the original loan is paid off and is replaced by a new loan agreement that requires lower interest payments.
Refinancing to release equity (cash-out refinancing): If you do not owe a lot on your bond and house prices in your neighbourhood have risen well since your purchase, you have more equity. In this case (when the value of an asset increases on paper) you can gain access to the value through a loan instead of selling. The main reason for such a loan is to release cash. Many people effect such loans to pay for home improvements that are supposed to raise the general value of the house.
Cash-in refinancing: This enables you as the borrower to pay off part of your loan in order to obtain a lower loan-to-value ratio (LTV) or smaller loan payments. A lower LTV could improve your loan risk and even bring about lower interest rates when next you apply for another bond.
Consolidation refinancing: Consolidation refinancing makes it possible for individuals to consolidate their debt into one amount and pay it back at rate of interest that is more affordable than what they are currently paying.
Some loans, especially balloon loans, must be paid back in one amount at a specific date. Perhaps you do not have funds available for a big lump sum on the due date. In these circumstances it would be sensible to refinance by using a new loan to finance the balloon payment. This will give you more time to redeem the debt.
Hint: Perhaps you could pay off a bit extra on the main amount every month to shorten the term of the loan instead of refinancing the loan. This could save you a considerable amount on interest.
Refinancing has several potential advantages
This could lower your monthly payments because you may qualify for a lower rate because of market conditions or an improved credit score – factors that were absent when you borrowed the first time. Lower rates of interest usually bring about considerable savings over the currency of the loan, especially in the case of large or long-term loans.
You can convert an adjustable rate of interest into a fixed rate of interest and so get predictability and possible savings.
You can get a cash inflow for an urgent financial need.
You can shorten the term of your loan, which will allow you to save money on the total interest you pay.
The general rule is that refinancing is worthwhile when the current rate of interest on your bond is at least two percentage points higher than the current market rate. However, no rule is cast in stone: each individual’s circumstances must be analysed and for that professional financial practitioners will be best.
However, refinancing is not always a smart money move. The following are some of the disadvantages:
If you have a fixed-rate bond, you gain nothing unless you refinance again.
The refinancing closing costs (which includes application fees, assessment, inspection fees and other costs) may be too high to make refinancing worth its while.
You will pay more interest on your debt if you draw out loans over a long period.
Some loans serve useful functions, which will be lost if you refinance.