image of person figuring out how to do their refinancing work

What is Refinancing and How Does It Work?

May 9, 2023

Refinancing is not only a key term in finance, it's also a useful tool in many financial situations.

For instance, you can refinance a loan to get lower rates or payments. You might also be able to refinance to take out a larger loan. Loan refinancing depends a lot on the loan provider you are using, but you can find refinancing options for all kinds of loans like car loans and home mortgages. 

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What Is Refinancing?

When you take out a loan you enter into an agreement with the lender. There are terms and conditions to read through, a payments plan, and a loan agreement to sign in order to get the loan. 

Refinancing is when you are able to replace this loan agreement with a new loan agreement. This new loan agreement might be different from your previous loan agreement in many ways. The interest rate might be lower, the number of payments you have left might be lower or higher, the amount you owe each month might be lower or higher, and so on and so forth. 

Usually, a loan borrower will refinance in order to change an aspect of their previous contract for a more favorable feature. This could include lower interest rates or more flexible payment options. 

what is refinancing definition

What is a Cash Out Refinance?

A cash out refinance is a type of refinancing for home mortgages that can help homeowners get the cash they need to make home improvements. It's a little like taking out a loan against the value of your home. 

For example, your home's total value is $200,000 so you take out a $200,000 mortgage loan to purchase your home. Later, after you've successfully paid off some of that, you still owe $100,000. But now you want to do a cash out refinance. Your loan will be reset to $200,000 but now you can get some of that $100,000 for the renovations you want to make. 

How Does Refinancing Work?

How this process works depends a lot on the lender you are using. Not all lenders offer refinancing options. Not all loan products that a lender has will offer refinancing options. Refinancing options may also depend on certain eligibility requirements from the borrower. 

To refinance, speak with a loan representative to see what options are available to you and your specific situation. If there are refinancing options available to you, then you'll most likely be given a new contract to sign with the changed features to your contract. 

Is Refinancing Worth It?

Finances are already a lot of work without choosing to make more work for yourself if it isn't really worth it. So how do you decide whether it's worth it to refinance? 

As with anything, you want to weigh the pros and cons. In order to effectively know what the pros and cons are, talk with a loan representative and go over your contract. What changes to the contract would work in your favor and which would not? Whether refinancing is worth it in the end all depends on what the refinanced contract includes. 

When to Refinance:

There are a few scenarios when it's a good idea to refinance if you can. Here are a few examples of instances when it might be worth it to consider refinancing a loan. 

When interest rates are lower 

The interest rates for some loans, like mortgages, can be affected by the current market. It might be worth it to refinance your mortgage for a better rate if a market trend causes mortgage rates to go down.

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When your credit score has gone up

One of the key factors considered when applying for a loan is the borrower's credit score. This score can impact the rate the borrower ends up getting. So borrowers with a lower credit score might end up with a higher rate and borrowers with a higher credit score might end up with a lower, better rate. This means that if your credit score improves enough, you might be able to resign a new loan contract at a better rate, reflecting your better credit score. 

When your home's value has gone up 

Your home is an investment and one of the returns on that investment can come from the property value going up. This could happen because of current market trends or because of renovations and improvements you've made. If you can show that you've significantly increased the original value of your home, you may be able to negotiate better loan terms on your existing mortgage. 

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When you can switch to a fixed rate

Did you know there are two kinds of rates? There are fixed rates, which stay the same throughout the course of the loan term, and then there are adjustable rates, which adjust with the market trends. There are pros and cons to both, but if you prefer a fixed rate that doesn't fluctuate and potentially increase, then switching to this kind of rate might be worth refinancing. 

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When you can remove a prepayment penalty

Some loans will come with what's called a prepayment penalty. This is a fee that the lender charges if the borrower pays off the loan early. If you have plans to pay off a loan early, it might be worth it to refinance your loan plan for one that doesn't have a prepayment penalty. 

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Should I Refinance My Mortgage?

A mortgage is a big investment. It gives you a home, a large asset, and a potential return on investment. Deciding whether to refinance your mortgage is a big decision. 

First, try considering why you want to refinance your mortgage. If this reason will also help you be better off financially, like getting a lower rate, then it's probably a good idea to go for it. If this reason will hurt you financially in the long term, like getting a smaller monthly payment now but repaying more in the end, then it might be better to consider other options instead. 

loan refinance

Should I Refinance Car Loans?

Car loans are perhaps more common than mortgages. A car can get old, break down, get into a crash, or just not serve you anymore and need to be replaced. However, refinancing a car loan can still be a big decision. 

You might want to refinance a car loan if any of the following apply to you: 

  • The dealer helped finance your car loan but you can get a better deal on a loan with a different lender now. 
  • The economy has changed and interest rates on car loans have gone down. 
  • The monthly car loan payments are too high and you want them reduced. 

Refinancing Short Term Loans

Car loans and home mortgages are usually larger loans that take several years to pay off. But these larger, long-term loans aren't the only type of loans out there. There are also short-term loans to consider. 

Refinance Title Loans

Title loans are short-term loans that can be taken out against the value of your car. You might want to refinance a title loan when you find you actually need a larger loan than you originally took out. 

Refinance Personal Loans

Personal loans are a short-term loan that is usually given to the borrower directly for personal expenses. You might want to refinance a personal loan if you want to pay off the loan early but a prepayment penalty is standing in your way. 

Refinance Payday Loans

Payday loans are a short-term loan that gives borrowers the money from their next paycheck now rather than later. You might want to refinance a payday loan if an emergency financial situation arises and you need quick cash today. 

Check City members can refinance their loan through the membership dashboard, if eligible. Please see our members FAQ page for more information or call us at (800)404-0254.

In Conclusion, 

Refinancing is a loan option that can help many set up their finances for the better. Whether this option is right for you depends on many things, but when done responsibly, can help you get better rates and pay less in the end. 

Whether refinancing is available to you will vary based on the loan provider and borrower qualifications. Talk directly with a representative from your loan provider for more details.