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To replace an existing debt with a fresh debt obligation bearing different terms, is referred as refinancing. A common refinancing for the consumers is the home mortgage.

Advantages of Refinancing

Refinancing at a lower rate may be undertaken to reduce interest costs, to extend repayment time, to pay other debts, to reduce one's periodic obligations of payment by taking convenient long-term loans, to alter or reduce risk by refinancing from variable rate to fixed rate loans or vice-versa, and to raise cash for investment or consumption or the payment of a dividend. In a nut-shell, refinancing is capable of changing the monthly payments owed ( on the loan) by changing the interest rate of the loan or by altering the maturity term of the loan. Favourable conditions of lending will reduce overall cost of the borrowing.

Another important factor associated with refining is it reduces the risk factor of the existing loan. The matter is especially significant in case of adjustable-rate loans and mortgages fluctuating up or down based on the movements of various indices used to calculate them. By refinancing an adjustable-rate mortgage to fixed - rate , the risk of dramatic escalation of interest rate is totally removed. Thus a steady interest rate for the entire period of loan repayment is ensured. But, the same flexibility if somebody wanted in the original loan condition, the lender would have asked for a hefty premium for the same.

So far as personal refinancing is concerned, refinancing a loan or a series of debts assist in paying high-interest debt such as credit card debt or low interest debt such as fixed-rate home mortgage. This allows a lender also to reduce borrowing costs by aligning the borrowing cost with general credit worthiness and collateral security available from the borrower. In the United States for home mortgages , there are some tax advantages available for refinancing in case of non payment .

Risks associated with Refinancing

Fixed-term debt mostly contains penalty clauses that are triggered by early payment of the loan, either fully or a specified portion. There are also closing and transaction fees typically associated with refinancing loan. These fees sometime outweigh the savings generated through refinancing the loan itself. One can think of refinancing only if there is substantial cost savings or if there is a need to extend the loan period due to lack of sufficient cash flow or due to other non-recurring commitments. Further, some refinanced loans, while having lower initial payments, may end up larger interest costs over the life of the loan period. Some of the refinanced loans exposes the borrower to greater risks than the earlier loan, depending upon the type of loan taken to refinance the existing debt. Therefore, whether or not to refinance depends on certain important criteria like calculating the up-front, ongoing and potential variable cost of refinancing.

Types of Refinancing

There are two types of refinancing namely, Cash-Out and No-Closing Cost. In Cash-out refinance may not help lower the monthly payment or shorter mortgage periods. If the borrower qualifies to get, it can be beneficially used by the borrower for home improvements, credit card and other debt consolidation and also keep the cash balance. In No-Closing Cost refinance, the borrower has to pay some upfront fees to get the new mortgage loan.