Have you ever wondered: What does refinancing a loan mean? Or perhaps asked, how does refinancing a loan work? In short, refinancing a loan means replacing an existing loan with a new loan.
In this article, we will go through the advantages of refinancing a loan and learn when to consider refinancing a loan.
Before we go any further, let’s understand the difference between the terms: finance and refinance.
When we say “finance a loan,” it generally means borrowing money from a financial institution. For example, getting a personal loan, home loan, car loan, or business loan. You are taking on a new credit contract and agreeing to repay in EMIs over a certain period of time with interest.
Refinancing means replacing an existing loan with a fresh loan under new terms. This is often to get a lower interest rate, better tenure, or structural changes. Basically, you pay off the old loan with the new one.
Simply put, refinancing a loan means taking a new loan under better terms to pay off your existing one. You can refinance a personal loan, home loan, auto loan, or even an education loan. For credit card accounts, this is also called “balance transfer.”
The goal is to get more favorable terms, which can mean a lower interest rate, a more suitable repayment tenure, or converting from a floating to a fixed rate. If your credit score has improved since you first took the loan, or market rates have fallen, refinancing can help you save money and manage your cash flow better.
Here are the steps to take if you want to refinance your loan:
Check your outstanding principal, current interest rate, remaining tenure, and any foreclosure penalties.
Look at banks, NBFCs, and fintechs. Compare interest rates, fees, and repayment flexibility.
Calculate your EMI under new terms
Compare the total interest outflow
Subtract fees like processing and prepayment charges
Check the “break-even point”. Figure out when the money you save from refinancing will be more than the costs you paid for it.
When you apply for a new loan, the lender will do a hard credit inquiry, which can cause a small dip in your score. This dip is temporary as the score can be rebuilt through timely payment of EMIs.
The new lender may directly pay off your old loan (loan takeover), or you might do it manually. Always collect closure proof.
Set up EMIs and pay on time. Regular payments will rebuild your credit score quickly.
Here are the benefits and risks of refinancing your loan:
|
Benefits |
Risks |
|---|---|
|
Lower interest rate and EMIs |
Upfront costs: processing, documentation, foreclosure penalties |
|
Better loan structure (shorter or longer tenure) |
Longer tenure may mean paying more total interest |
|
Option to consolidate multiple debts |
Temporary dip in credit score |
|
Improved creditworthiness with on-time payments |
Loss of “credit history age” if the old loan was long-standing |
Refinancing your loan can affect your credit score adversely, but it can be repaired within a short period of time.
When you apply for a new loan, the lender runs a hard inquiry. Moreover, the closure of the old loan account reduces your average credit age. Both of these reasons can cause your credit score to dip.
Usually, only a few months. With timely new payments, your score can rebound quickly.
Follow these tips to minimise the impact of refinancing on your credit score:
Apply for a new loan with only one or two lenders
Ensure the old loan closure is documented
Always repay new EMIs on time
Avoid taking another big loan right after refinancing
In certain circumstances, it is advisable not to refinance existing loans. Do not opt for refinancing if:
If the remaining loan tenure is very short
If your credit score has declined
If your old loan has heavy penalties for closure
If you prefer stability and do not want to risk changing terms
Refinancing a loan can help you cut costs, ease repayment, and make the most of market changes. But it works best only if savings outweigh fees, your credit profile supports a better rate, and you manage repayments responsibly.
Used wisely, refinancing can be beneficial in the short and long term, but it pays to run the numbers before you switch.
Disclaimer
The starting interest rate depends on factors such as credit history, financial obligations, specific lender's criteria and Terms and conditions. Moneyview is a digital lending platform; all loans are evaluated and disbursed by our lending partners, who are registered as Non-Banking Financial Companies or Banks with the Reserve Bank of India.
This article is for informational purposes only and does not constitute financial or legal advice. Always consult with your financial advisor for specific guidance.
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