Refinance / Refinancing: Reasons and Risks
A method of paying a debt by borrowing additional money thus creating a second debt in order to pay the first. The most common consumer refinancing is for a home mortgage.
A loan (debt) can be refinanced for various reasons:
1.To take advantage of a better interest rate (which will result in either a reduced monthly payment or a reduced term)
2.To consolidate other debt(s) into one loan (this will result in a longer term)
3.To reduce the monthly repayment amount (this will result in a longer term)
4.To reduce or alter risk (e.g. switching from a variable-rate to a fixed-rate loan)
5.To free up cash (this will result in a longer term)
In the context of personal (as opposed to corporate) finance, refinancing multiple debts makes management of the debt easier. If high-interest debt, such as credit card debt, is consolidated into the home mortgage, the borrower is able to pay off the remaining debt at mortgage rates over a longer period.
Most fixed-term loans have penalty clauses ("call provisions") that are triggered by an early repayment of the loan, in part or in full, as well as "closing" fees. There will also be transaction fees on the refinancing. These fees must be calculated before embarking on a loan refinancing, as they can wipe out any savings generated through refinancing.
If the refinanced loan has lower monthly repayments or consolidates other debts for the same repayment, it will result in a larger total interest cost over the life of the loan, and will result in the borrower remaining in debt for many more years. Calculating the up-front, ongoing, and potentially variable costs of refinancing is an important part of the decision on whether or not to refinance.
In banking and finance, refinancing risk is the possibility that a borrower cannot refinance by borrowing to repay existing debt. Many types of commercial lending incorporate balloon payments at the point of final maturity; often, the intention or assumption is that the borrower will take out a new loan to pay the existing lenders.
A borrower that cannot refinance their existing debt and does not have sufficient funds on hand to pay their lenders may have a liquidity problem. The borrower may be considered technically insolvent: even though their assets are greater than their liabilities, they cannot raise the liquid funds to pay their creditors. Insolvency may lead to bankruptcy, even when the borrower has a positive net worth.
In order to repay the debt at maturity, the borrower that cannot refinance may be forced into a fire sale of assets at a low price, including the borrower's own home and productive assets such as factories and plants.
Most large corporations and banks face this risk to some degree, as they may constantly borrow and repay loans. Refinancing risk increases in periods of rising interest rates, when the borrower may not have sufficient income to afford the interest rate on a new loan.
Most commercial banks provide long term loans, and fund this operation by taking shorter term deposits.In general, refinancing risk is only considered to be substantial for banks in cases of financial crisis, when borrowing funds, such as inter-bank deposits, may be extremely difficult.
A loan (debt) can be refinanced for various reasons:
1.To take advantage of a better interest rate (which will result in either a reduced monthly payment or a reduced term)
2.To consolidate other debt(s) into one loan (this will result in a longer term)
3.To reduce the monthly repayment amount (this will result in a longer term)
4.To reduce or alter risk (e.g. switching from a variable-rate to a fixed-rate loan)
5.To free up cash (this will result in a longer term)
In the context of personal (as opposed to corporate) finance, refinancing multiple debts makes management of the debt easier. If high-interest debt, such as credit card debt, is consolidated into the home mortgage, the borrower is able to pay off the remaining debt at mortgage rates over a longer period.
Most fixed-term loans have penalty clauses ("call provisions") that are triggered by an early repayment of the loan, in part or in full, as well as "closing" fees. There will also be transaction fees on the refinancing. These fees must be calculated before embarking on a loan refinancing, as they can wipe out any savings generated through refinancing.
If the refinanced loan has lower monthly repayments or consolidates other debts for the same repayment, it will result in a larger total interest cost over the life of the loan, and will result in the borrower remaining in debt for many more years. Calculating the up-front, ongoing, and potentially variable costs of refinancing is an important part of the decision on whether or not to refinance.
In banking and finance, refinancing risk is the possibility that a borrower cannot refinance by borrowing to repay existing debt. Many types of commercial lending incorporate balloon payments at the point of final maturity; often, the intention or assumption is that the borrower will take out a new loan to pay the existing lenders.
A borrower that cannot refinance their existing debt and does not have sufficient funds on hand to pay their lenders may have a liquidity problem. The borrower may be considered technically insolvent: even though their assets are greater than their liabilities, they cannot raise the liquid funds to pay their creditors. Insolvency may lead to bankruptcy, even when the borrower has a positive net worth.
In order to repay the debt at maturity, the borrower that cannot refinance may be forced into a fire sale of assets at a low price, including the borrower's own home and productive assets such as factories and plants.
Most large corporations and banks face this risk to some degree, as they may constantly borrow and repay loans. Refinancing risk increases in periods of rising interest rates, when the borrower may not have sufficient income to afford the interest rate on a new loan.
Most commercial banks provide long term loans, and fund this operation by taking shorter term deposits.In general, refinancing risk is only considered to be substantial for banks in cases of financial crisis, when borrowing funds, such as inter-bank deposits, may be extremely difficult.
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