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What is loan refinancing and why you should care

Posted 23.09.2020
What is loan refinancing and why you should care

When you refinance a loan, you get a new loan in place of the old one. You might wonder what difference refinancing makes if you still owe the same amount, but it can be highly beneficial in the following circumstances:

  • The new loan has a lower interest rate, so you save money.
  • Your preferences have changed; for example, if you have a secured loan, you might no longer want to use your personal property as security.
  • Overall, the new loan has more benefits, better features, greater flexibility, plus more positive aspects that improve your financial situation.

If your current loan isn’t working for you, find out how refinancing can optimise your situation.

Refinancing your loan: How do you do it?

Refinancing your loan is as simple as applying for a new loan. You then use this new loan to pay off your old loan completely. If you have applied for a loan before, then you’re probably familiar with the refinancing process:

  1. Do some research to find out which reputable South African personal loan lenders offer loan refinancing.
  2. Go through the details of each loan offer and consider factors like: 
  • Interest rate
  • How much you can borrow
  • Which loan terms are available
  • Repayment flexibility
  • Loan charges and fees 
  • Other features of the loan
  1. If the new loan sounds good go ahead and submit your application!
  2. Use the cash to pay off the old loan and start making payments on the new loan, which hopefully has better features all round.

You don’t have to feel trapped by your loan

You might have taken out a loan only to find out later on that it has certain features you wish to change. Here’s where refinancing can be a lifesaver. Instead of being stuck with a less-than-optimum loan for years, you can fix these issues. A big bonus is that refinancing works for most types of loans:

Usually, when you take out a loan, you want to benefit from the lump sum of money. You also want to borrow the money at the lowest cost possible. That means a low-interest rate and fewer charges and fees. These low-cost features are not always available when you apply for your loan. Once they become available, then it might be time to refinance the loan.

Common refinancing examples

Other times your situation changes, and you realize that a new loan with different features might be safer and has less risk. You might want to change the following features:

  • Variable interest rate – If the interest rate goes up the loan might become too expensive for you, and switching to a fixed interest rate loan might be a better option.
  • Fixed interest rate – If the interest rate goes down, you might not be able to benefit if you have a fixed-rate loan. Switching to a variable rate loan gives you a lower starting interest rate.
  • Balloon payment – A balloon loan requires you to pay a lump sum of money at the end of the loan agreement. If you can’t afford this simply apply for a new loan to cover the balloon payment.
  • Secured loan – Refinancing a secured loan to an unsecured loan means you remove the risk of losing your asset or personal property.
  • Unsecured loan – You can get a lower interest rate and better loan terms by switching to a secured loan if you have the right type of asset.
  • Loan terms – A longer loan term reduces your monthly repayment amount, which improves cash flow. On the other hand, a loan term means your monthly repayments increase, but you save on interest since you can pay off the loan quicker.
  • Refinancing your home loan to get your equity back – This allows you to get back the balance you have already paid towards your home loan. This frees up a lump sum of cash you can use for anything you like, including paying for a holiday, wedding, or home renovation.

At the same time avoid these refinancing mistakes

Refinancing isn’t always a smart move, especially if you end up increasing the total costs of your loan. During the process, you might need to pay additional costs as you close the old loan and initiate a new one. The lender might charge administrative fees to refinance the loan so always make sure you’re not getting yourself further into debt.

Another mistake to avoid is choosing a new loan that doesn’t have some crucial advantages of your old loan. As an example, your new loan might not allow early or additional repayments unless you pay a penalty fee. In this case, the best option is to take out a new loan that allows you to keep the top benefits of your old loan.

Also, when refinancing, it’s best to take steps that ensure credit score is in the best shape possible. That means paying your monthly instalments and avoiding taking out other personal loans before and during the refinancing process. A low credit score and a poor credit history can hinder you from getting a better deal.

Besides refinancing, what else can you do?

After doing some calculations, you can decide that refinancing a loan might currently not be the right option for you. Here’s what you can do instead:

  • If you want to minimise the total cost of your high-interest loan, you can speed up the loan payments to avoid accumulating interest.
  • You can simply approach your current lender and negotiate a loan restructuring. 

Main points to remember when refinancing your loan

  • The purpose of refinancing a loan is to switch to a different loan that has better features.
  • When done correctly, refinancing offers benefits that include more affordable monthly payments, a lower interest rate, and more savings.
  • In addition, you can refinance your loan to get your equity back which gives you money that can be used for many purposes.
  • However, refinancing can become too costly if there are too many fees involved during the refinancing process. 
  • Ultimately, the best thing is to use the information in this article to assess your individual situation and figure out if refinancing is the best option for you.

Photo by Humphrey Muleba on Unsplash