What is Refinancing?
How Refinancing Works
Financing involves borrowing a specific amount of money over a length of time at an agreed-upon interest rate. Payments on the debt are divided between interest and principal. If circumstances change, for example, the length of time needed to repay the debt is longer and the lender agrees, the loan may be refinanced. This will extend the term and lower the period payments (because they are extended over a longer period of time). If interest rates change, the debt may also be refinanced using a lower interest rate.
For example, the $150,000 loan below is shown with a term of 15 years at 8% per year. By year 5, the market interest rate drops to 5%. When the loan is refinanced over the balance of the term, for example, the savings in principal and interest payments on the loan will be over $32,000.
Refinancing may also convert an adjustable rate mortgage to a fixed-rate mortgage, reducing the interest rate risk to the borrower.
Why Refinancing Matters
Refinancing may be restricted on debts containing "call provisions," requiring a penalty payment in the event of a refinancing. In addition, a refinancing usually requires a closing and transaction fee that may be expensive. As a result, it is important to calculate the present value (the value in today's dollars) of the savings and compare it to the closing costs of the refinancing.
Personalized Financial Plans for an Uncertain Market
In today’s uncertain market, investors are looking for answers to help them grow and protect their savings. So we partnered with Vanguard Advisers -- one of the most trusted names in finance -- to offer you a financial plan built to withstand a variety of market and economic conditions. A Vanguard advisor will craft your customized plan and then manage your savings, giving you more confidence to help you meet your goals. Click here to get started.
Read This Next
Tell me if this sounds familiar: Your parents have failed to save enough money for retirement and their ability to work is limited. Or their savings were hit by the last debt and housing crisis...Read More →
You probably should have read this article before you took your first job out of college. And you definitely should have read it before you walked into your company's HR office and signed on the...Read More →