How Does Refinancing a Loan Work and How Can It Save You Money?

Even if you budget well, you may be looking for financial relief where you can. One possibility that many people don’t consider (because it can seem a bit overwhelming) is refinancing. This financial strategy can give you a bit of breathing room in your budget — and possibly better loan terms, too.

Right now, you may be wondering, “How does refinancing a loan work?” Let’s take a look at what refinancing is and how you can use it to get some wiggle room in your budget.

How Does Refinancing a Loan Work?

Generally, you want to seek refinancing to obtain more favorable lending terms such as a lower interest rate or a fixed interest rate instead of a variable one. If interest rates drop, you’ll have to refinance to take advantage of the new rates.

The term “refinance” can be slightly misleading. It may seem like you’re redoing your loan, but you aren’t — you’re actually replacing it with an entirely new loan. You can either refinance with your current lender or work with a different lender.

Refinancing is quite simple. You’ll approach either your current lender or a new one with your refinancing request and apply for a new loan. It’s important to note that refinancing involves rechecking your financial situation and credit terms. You’ll want to pay close attention to what the new loan offer is compared to your current loan offer and understand changes in payment amounts, interest rates and payoff timeline.

If your loan application is approved, it’s used to pay off the balance on your current loan. You can refinance your house mortgage, auto loan and even your student loan debt. Refinancing may lead to at least one of several benefits. It can help you lower your monthly payments, lower your interest rate, or help you pay off the loan sooner under a shorter loan term.

Types of Refinancing Options

There are several different types of refinancing options available, including:

Consolidation 

This option can be used when you want to obtain a single loan at a lower rate than the current rate you pay across several other credit cards or loans. You’ll pay off the individual loans with the consolidation loan, then only make payments on the consolidation loan. This is a popular option for student loans and credit cards.

Cash-In

This enables you to pay down some of your loan for smaller loan payments.

Cash-Out

This is common when the asset being used as collateral for the loan, such as a house, increases in value. With a cash-out refinance, the value of the asset is withdrawn in exchange for a larger loan amount. However, this is generally accompanied by a higher interest rate as well.

Rate-and-Term

This is the most common type of refinancing option. It occurs when the current loan is paid off and replaced by a new loan with lower interest.

When Is the Right Time To Refinance?

Has your credit dramatically improved since you originally got your auto loan or mortgage? If so, your improved financial situation may be able to save you money on a refinanced loan.

It’s important to consider how long it will take you to pay off the refinanced loan, whether you can afford the adjusted payment and how much the closing costs are. If you can shorten the length of your loan (and thus save money on interest), you may want to consider refinancing. It’s important to note that your monthly payments may increase, but you’ll save money over the long term.

Explore Your Financing Options

Now that you’ve explored answers to your question “how does refinancing a loan work,” you may want to explore how much breathing room refinancing can create in your budget. 7 17 Credit Union has several financing options to meet our members’ financial needs. Explore our loan refinancing options today to find out how to achieve your goals.