In the present economic situation of falling interest rates, it is an open opportunity for home buyers to minimise their cost of home purchase. The perfect time to purchase one’s dream property at an affordable loan rate. Even the existing home loan borrowers will be able to save large amount of money through refinancing of their loan.
Refinancing can be defined as the process of paying off an existing loan with the proceeds from a new loan, usually of the same size, and using the same property as collateral. It simply means to take a new loan for repayment of your existing loan. The terms and conditions of the new loan should be such which offers an advantageous position or substantial savings to the Borrower as compared to the old loan. For refinancing to be viable, the proposed savings should be larger than the component of cost involved in it. Normally, the refinancing option can be exercised only upon payment of a penalty or fee.
Refinancing is done mostly for two reasons- savings or modification of deadline for loan payment or both.
When a person swaps the existing loan with another loan at a lower interest rate, then the difference in interest rates automatically make way for savings.
On refinancing, the borrower gets an extended deadline for repayment of loan by undertaking a new loan. Like a person who needs to pay off a loan in near future but does not have the funds for repayment, can refinance his loan. This prevents the Borrower from becoming bankrupt.
Similarly, the extension of timeline can be used for reducing the EMI payments payable to banks.
For some people, it maybe the long duration of loan is a cause of concern. By entering into a loan agreement with new terms and conditions, the timeline for loan repayment can be drastically shortened. This leads to savings in terms of reduction in number of interest payments.
Another reason for refinancing can be to switch from a variable rate to a fixed rate loan or vice versa.
In case of multiple loans, one can use refinancing to consolidate those loans into one single loan especially for an offer of lower interest rate. It also makes tracking of the loan and interest payments easier.
Benefits of refinancing.
1. Savings: A common reason for refinancing is to save money on interest costs.
2. Improved cash flow: Refinancing can lead to lower EMI payments due to the extension of timeline for loan repayment. This enables easy cash flow management and addressing of new expenses.
3. Reduction in loan amount– The loan tenure is inversely proportional to the amount of EMI payments. This means the higher the tenure, the lesser the amount of your EMI payments and vice versa.
4. Early loan exit– If there is an increase in the cash inflow, one can be free from loan by making larger EMI payments for a shorter loan term.
5. Modification of loan terms like fixed rate to fluctuating rate of interest or vice versa, to suit the present financial standing of the individual or to meet the present and future expenditures.
6. Deployment of money into other investments– If you are planning to make another investment, refinancing is a smart move for diversion of funds into other profitable ventures provided you are good at financial planning and management.
7. Improved credit rating– As the existing loan is paid off before due date, it improves or maintains the credit rating of the individual which is important for securing future credit requirements.
Checklist before refinancing
Refinancing is beneficial. However, there are some factors which need to be taken into account before jumping into the decision of refinancing.
- Transaction costs: Refinancing can be expensive if the closing cost involved in a loan is too high.
- Additional interest costs: Though one enjoys lower EMI payments on an extended loan period, it may actually lead to higher amount of interest payments in totality.
- Lost benefits: Some loans have important features that may go away on refinancing. For example, a fixed-rate loan might be ideal if interest rates are high even if you temporarily get a lower rate with a variable rate loan.
It is important to remember that refinancing should be done only when the aforesaid factors are outweighed by the positive outcomes of new arrangement. Also be mindful of the fact that though refinance conveys alteration in financial management, there are certain ground realities which remain unchanged.
1. Existence of the same amount of debt or more in case closing costs are involved.
2. Risk of losing the same collateral security – property in case of home loan, on non-repayment.
3. Be aware of the new payment structure and its components, to evaluate its long term impact on your financials.
4. Refinancing your home loan comes at a charge, which differs from bank to bank. Make sure that the profit you make by opting for refinancing is higher compared to the fee and charges you pay. In most of the cases, it is profitable
Refinancing is a calculated move and therefore, one needs to be aware of the discussed factors, in order to reap the potential benefits out of it. In the current scenario of skydiving interest rate, it is the perfect time for refinancing of home loan. From a micro perspective, an individual has to do the required math and proper balancing between payments and savings, to qualify for the advantages of refinancing of home loan.