Typically when a borrower takes out a loan such as a student loan or a home mortgage, the borrower agrees to repay the loan with added interest over a length of time. When it comes to refinancing, the borrower obtains a new loan that covers and repays the previous debt while usually benefitting from terms to help in money savings or a faster repayment. This advantage makes refinancing a great choice for many.
Considering the type of loan and your situation, you could stand to benefit from a refinance to get your loan on better terms. The factors going into the decision should be weighed appropriately before making this important financial decision.
Categories of Refinance Loans
Loans that a borrower takes out can be secured or unsecured. The type of loan that may be favored depends on the borrower and their situation. With secured loans such as a home mortgage or a car loan, the debt is tied to an asset that can be repossessed should the borrower default or fail to pay under the terms of the loan. Unsecured loans differ from secured in that they are not tied to an asset in this way. Personal loans and credit cards are examples of unsecured loans. With these, your credit score and other criteria such as income are used to determine eligibility and ultimately the interest rate you will pay.
The simplest form of refinance is a rate-and-term refinance, where the size and scope of the loan are not altered. The interest rate or other terms of the loans are changed but there is no other cost other than potential transaction costs. The interest rate can be locked in at a lower rate or the terms of the loan can be set to pay off the debt sooner and save on interest on the whole.
A cash-out refinance is another common tool used by borrowers that is also used for debt relief of other obligations or providing the cash on hand for the borrower. This type of refinance has a major drawback in that the home loan balance will increase, and defaulting on the refinanced mortgage could mean losing your home in foreclosure.
The last type of refinance we will go into is a cash-in refinance loan. Here, the borrower repays a portion of the loan balance in order to qualify for new loan terms that will lead to lower interest and a faster repayment of the loan.
When making the choice to refinance, there are a few considerations to make. It depends on the terms of the new loan, but typically refinancing can help you with making lower monthly payments and change the repayment period for the loan. You may wish to lower your monthly payments to allow for more budget freedom or shorten the length of time to repay the loan so that you can relieve the debt at a faster pace. Refinancing can also restructure your payments so that you save on interest and lower the risk of default. Refinancing can also be a means of consolidating debts which can help struggling borrowers with their monthly payments but, ultimately, they will still need to repay the total balance owed.
The loans you can refinance are not limited to home mortgage loans but can include car loans, your student loans, personal loans, and credit card debt. You will owe on your original balance amount and the debt will remain until the refinanced loan is repaid. There are different categories of refinancing should you choose this path.
Refinancing could work well for some borrowers, but there are times when refinancing is expensive to the point of nullifying the benefits. Upfront origination fees from the lender, fees or penalties for processing, interest costs over the length of the loan (if the borrower opts for a longer repayment term to lower monthly payments for example), closing costs, and a longer time in debt can outweigh the benefits. Sometimes it does not make sense to refinance with all this considered.
Debt Settlement vs. Refinance
With the drawbacks of refinancing outlined above, debt settlement may appeal to the borrower trying to avoid the added costs, especially considering a cash-out refinance. Debt settlement won’t increase the balance of your debts and can ultimately save you much more in interest over the long run.
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