Loan refinancing is paying off a debt completely by getting another loan, in other words, robbing Peter to pay Paul. This is essentially due to a more favorable lending condition for the borrower.
A typical example of this will be in terms of interest rate. Say Mr. A borrows a sum of N10m to pay off his mortgage at an interest rate of 10% for a period of 1 year, if Mr. A gets the same principal from another lender at an interest rate of 5% for a duration of 2 years, and he decides to borrow from lender 2 to pay off lender 1, that is loan refinancing.
In this case, lender 2 has given Mr. A, a cheaper interest rate, so it just makes sense to borrow money from him instead and repay lender 1; who is way more expensive, off.
Some factors to consider when refinancing a loan
- Interest rate: An essential factor, in fact, almost the bedrock of loan refinancing is the interest rate. As seen in the example above, Mr. A decided to go with lender 2 because of the reduced interest rate, although he has to pay for a longer period.
- Monthly income/savings: Monthly savings in relation to income is also an important factor to consider when refinancing a loan. For example, borrowers may need to pay more than half of their income monthly. To this category of people, having the slightest opportunity to refinance a loan, if it will mean they can reduce the fraction of income they get to apportion to loan repayment, then that will be a good option.
Cons of Loan Refinancing
Tedious process of refinancing: Loan refinancing is like applying for a new one all over again which can be quite cumbersome. The process of getting an account officer’s consent, getting an account statement and other processes might not be a very good experience for some and they might never want to repeat that process.
Refinancing risk: This happens when a debt cannot be refinanced because of a bad credit rating. Before lenders agree on the terms of refinancing, they look into how the borrower has been in the last repayment. If the borrower has a bad repayment structure or he has not been reliable, loan refinancing may not be possible.
How loan refinancing can be helpful during debt crisis
Loan refinancing can be very helpful when trying to solve debt problems, especially in a situation where the duration of repayment is almost completed and the borrower cannot afford to pay back. However, recall that lenders mostly look into the previous repayment methods before a new loan can be granted, in this case, it may be advisable to refinance the loan at an early stage, once it is detected that the repayment might be cumbersome, either because of the interest rate, duration of repayment or other reasons.
There is no one answer to loan refinancing, it can either be a good or bad decision, depending on the situation at hand. Borrowers must weigh the pros and cons before refinancing.