Posted in Finance, Accounting and Economics Terms, Total Reads: 404
Refinancing is the replacement of a present obligation of debt with other debt obligation under different conditions and terms. The refinancing terms and conditions vary extensively by province or country or state depending on various economic factors such as, credit risk, inherent risk, political stability of a nation, projected risk, currency stability, borrower's credit worthiness, credit rating, and banking regulations of a nation. A usual way of refinancing in many industrialized nations is for a place of principal residency mortgage.
Debt replacement occurs under financial problems or distress. In such a case, refinancing might be referred to as debt restructuring.
Refinancing of debt can occur due to the following reasons:
1. To take benefit of a better interest rate (a decreased monthly EMI payment or a reduced term of the obligation)
2. To reduce or alter risk (e.g. switching from a variable-rate to a fixed-rate loan)
3. To combine other debt into a single loan (a possibly shorter/longer term contingent on differential interest rate and fees)
4. To release cash (often for a higher term, contingent on differential interest rate and fees)
5. To decrease the monthly EMI repayment amount (often for a long term, contingent on differential interest rate and fees)
Refinancing for reasons 3, 4 and 5 are usually undertaken by borrowers who are in financial so as to decrease their monthly EMI repayment obligations with the penalty that they would take longer to repay their obligation
For example, suppose one takes a Rs 1,50,000 loan with a period of 15 years at 8% per year. Now, by the 5th year, the market interest rate reduces to 5%. If the loan is refinanced over the balance of the period, the savings on loan in principal and interest payments will be over Rs. 32,000.