What is refinancing?
In layman’s terms, refinancing is when you replace an existing debt – or in some cases, multiple unsecured debts – with another debt that has more favourable terms. That way, you can manipulate the terms of your debt obligations to your advantage.
People refinance their debts either because their terms are not favourable when compared to prevailing market terms, or when they have difficulty or are no longer able to honour their existing debts.
Market interest rates do not stay stagnant – they ebb and flow like water, and the terms of your loan can quickly become unfavourable if the market moves a certain way. When the interest rate of a personal loan is above market rates, you can save money in the long run by refinancing your loan to have the lower interest rate.
Building further upon this concept, refinancing is not restricted only to single loans, but it can also be used to consolidate multiple debts into one large debt that has more favourable terms (either a better interest rate or shorter/longer term) and saves more money in the long run than all the smaller, individual debts combined.
Besides this, refinancing can also be used to switch between fixed interest rate and variable interest rate, depending on which is more advantageous to the borrower. The benefit of having a fixed rate is that uncertainty is removed and the borrower is not put at the whims of fluctuating interest rates, but by the same token, they also cannot take advantage of a drop in interest rates.
Variable interest rates however, can take advantage of an interest rate drop, but at the same time they are also vulnerable to an unexpected rise in interest rates. So there are pros and cons to both types of interest rates, and refinancing can help a borrower to choose one that suits his or her needs and risk profile better.
Of course, beyond just manipulating the terms to fit your own situation, refinancing is also often used by people who suddenly find themselves struggling to or unable to honour the original terms issues. A common term for refinancing of this nature is ‘debt restructuring’.
For people who can’t afford to pay the monthly instalments anymore, the monthly repayment amount can be reduced, usually at the cost of having to bear a longer repayment term, and also subject to various fees that may be imposed by the lender.
Refinancing can also be used to get extra cash to remedy liquidity problems by taking out a larger loan that covers both the original loan(s) and also leaves a surplus of cash for immediate use. However, lenders should ascertain their ability to repay such a loan beforehand, as the risk of biting off more than you can chew is quite high with this kind of refinancing.
Key Things to Look Out For When Refinancing Your Personal Loan
Review Your Credit Score
Your credit score will have a large impact on how successful your efforts at refinancing will be, because a good credit score and payment history will give you more leverage when negotiating for new terms. If you’ve been keeping up on your payments, your credit score should have improved since you first took out the loan. If there are any problems that pulling down your score, consider clearing some of your credit card debts and make a few more payments on time to try and improve your score so that you can qualify for best interest rates.
In Malaysia, you can obtain your credit report by visiting a Bank Negara Malaysia branch. Remember to bring your Mykad and any other supporting documents for identity verification like your driving license or your passport. You can learn more about the branch locations and how to obtain your credit report here.
Do Your Research On Personal Loans
Find out if your lender can offer you better terms on a refinance. If not, do some research on other financial institutions to see which one can give you the best terms. You can use the Loanstreet website to compare personal loans offered from a variety of institutions.
When learning about what terms institutions are willing to offer you, make sure to read the loan documents thoroughly for items such as prepayment penalties, balloon payments, payment and adjustment details, etc. Never agree to accept loan terms on the same day that you apply for the loan. Ask for a sample documents so that you can take your time to review the contract at home. If you rush into accepting the new loan terms, you may find yourself in a worse position than with the original loan.
Calculate the Cost of Refinancing
Understandably, lenders aren’t too fond of the idea of their debtors jumping ship every time they find better loan terms on the market, so be aware that refinancing isn’t free. Make sure to take into account the possibility of expenses like application fees, early repayment fees, origination fees and ongoing fees, to name a few, when deciding whether or not to refinance your loan. It’s possible that you may end up worse off or that the potential savings from the refinance become significantly diminished due to these expenses, so be sure to cover your bases and calculate all these things precisely before making your decision.
Make Sure Your Original Loan Has Been Closed Out
Remember to follow up on the original loan with your lender to make sure that your debt has been cleared up. If you receive no word from them, make sure to call them up to double check, or obtain another credit report to make sure that the old loan has been paid off. It always pays to be careful.
The world does not stay still in one place forever, and neither should you. As time passes, the market changes, and so does your financial situation. By refinancing your debts when it is advantageous to do so, you can save money in the long run and put yourself in a better financial position. Refinancing can also be a tool to help you survive should you find yourself in financial distress. We hope the knowledge and tips you have gained from this article will help you if you decide to refinance your personal loans in the future.