What is refinancing?

Features

1. Refinancing simply means paying off one debt with another loan, using the same assets as collateral. Most home or car purchases are financed with terms that extend for a certain period of time at either a fixed or adjustable interest rate.
   In a refinancing situation, a new loan is borrowed to retire the original mortgage, usually at a lower rate or longer period or both, often creating a lower monthly payment for the mortgagor.
   Credit card debt can also be informally refinanced by renegotiating terms or transferring a balance to another card, but the term is seldom applied to such situations.

   Function

2. Refinancing is voluntary, so it almost always serves to provide some value to the borrower. If the cost of refinancing is less than the potential savings, the difference can be a major motivation to refinance.
   In other cases, refinancing is simply used as a way to tap into home equity, especially when mortgage rates are lower than comparable lines of credit. Because the borrower is putting up his home as collateral, he can usually borrow the full market price of the house. If the amount of the first mortgage is less than the market value, the difference is equity.

   Significance

3. Financing and refinancing have been providing flexibility to modern capitalist economies for a long time, allowing owners to take advantage of low rates and cheap credit. From 2002 to 2006, refinancing homes became a major source of funding to U.S. households, resulting in a short-lived period of relative prosperity.
   A major consequence of the real estate collapse after 2006 was the closing of access to home equity through cheap refinancing, which in turn crimped consumer spending and sent ripples through the entire economy.

   Effects

4. Refinancing can either make a loan cheaper or more costly. For refinancing to make sense, either the credit rating of the borrower should have improved or interest rates should have declined. In either case, the borrower can pay off a new loan faster without increasing their monthly payments. On the other hand, monthly payments can sometimes be decreased by greatly extending the period of a loan, but this will usually make the total cost of the loan greater.

   Considerations

5. While using refinancing to get at equity seems like free, cheap money, in reality, it amounts to spending one's savings. Cars are less frequently refinanced because the terms of auto loans are much shorter, the principal is much lower, and a car is easy to repossess.
   Homes are more difficult to possess and resell, and can store a vast amount of wealth, so lenders are more willing to refinance. Borrowers should resist using home equity as cheap credit, however, and consider the full ramifications before refinancing.