What Is Refinancing? How Does It Work?

Anyone with an existing loan from a bank or other recognised lender may contemplate refinancing at some point during the life of the loan if it can save them time and, more importantly, money. Refinancing, as the name suggests, refers to paying out an existing loan by taking out a new one, either with a current lender or a new one, under more beneficial circumstances.

In Australia, mortgages (home loans), personal loans, and credit cards are usually flexible enough for you as the borrower to refinance, either through your existing lender or a new one.

Why refinance?

Refinancing a home loan or other types of debt can put you ahead financially as long as you fully understand the terms and conditions attached to your existing loan and the new loan you wish to refinance with.

Some reasons to refinance include:

A lower interest rate

Any loan refinancing that saves you money, by definition, is a good thing, and the most obvious starting point is the interest rate. The interest rate will always determine the term or length of a loan and the final amount you pay. Refinancing to a lower rate could save you thousands, or even tens of thousands of dollars in the case of a mortgage, in the long run.

There are also potential savings with credit card refinancing, especially where you can do a balance transfer when you change lenders. These offers can involve an interest-free period of 18 months or even longer.

Lower fortnightly or monthly repayments

Refinancing often involves revised loan terms and conditions, especially when you change lenders. So, if you’re struggling to pay the set amount agreed upon on your current loan, you may be able to refinance to lower those minimum repayments.

Just be aware that the less you pay, the longer it will take to repay the loan, and the final amount payable will be higher. That is especially true with credit cards, where your lender is more than happy for you to pay the minimum amount required because it means paying them back much more in the long run than if you pay out the loan earlier.

Better terms and conditions

Each loan comes with various terms and conditions, such as annual or monthly fees, a fixed or variable interest rate, principal and interest or interest-only, and penalties for paying the loan out early.

Most lenders will allow you to move from a fixed loan to a variable one or vice versa, depending on the type of loan. However, exiting a fixed loan for a variable one early may come with higher accompanying charges.

Generally speaking, the larger the loan, the more complex the terms and conditions. So, if you’re refinancing a mortgage, you’d want to talk to a mortgage broker or financial adviser. For personal loans and credit cards, you may find it easier to do your own research — as long as you thoroughly review the loan terms before deciding to refinance.

» MORE: Fixed vs. variable interest rate home loans

Debt consolidation

Having multiple debts where you have to perform what feels like a ceaseless juggling act of repayments every month can be exhausting. Debt consolidation, where you roll some or all of your existing debts into one loan with one repayment and reduced overall interest rate, can be a good strategy.

It can bring greater financial peace of mind as there are fewer monthly bills to budget. That is especially true in the case of credit cards, where the debt keeps on racking up over time. And you may have to contend with constant late payment fees if you’re struggling with all your commitments.

If you’re serious about getting out of debt, you may want to consider debt consolidation.

Potential to improve your credit rating

You may have a relatively low credit rating due to missed payments or defaults over an extended period in the past that has affected your ability to get a good personal loan, for example. But, if you make regular repayments over a 12-month period without incident, you may be able to renegotiate the terms of your current loan or refinance with another lender due to your improved credit rating. Once your circumstances improve, you are in a better position to obtain a more favourable loan.

Refinancing eligibility and what to look out for

Your ability to refinance will depend on the terms and conditions of your current loan and your financial circumstances. If you decide to refinance a loan, you should be mindful of your choices and not be too quick to jump on the first offer. Look at what you want in a loan and see what lenders are offering what — for example, in establishment or annual fees.

Additionally, before you refinance, see if you can negotiate with your current lender to obtain the same result. If, for example, you have a personal loan with a bank and you see an offer from another one for a lower interest rate and cheaper annual fees, or no annual fees at all, ask your lender to match it. Doing so could save you all the rigmarole involved in changing lenders. Lenders may be amenable to this, given the amount of competition in the marketplace. There’s no harm in asking.