“What is refinancing? I hear people talking about refinancing their home, their student loans, but what is refinancing and how does it work?” We frequently hear a version of this question and it’s a good one. People are told they should refinance, they hear friends and neighbors talking about it, but what exactly is it?
Refinancing is just swapping out an existing loan (or loans) for a new loan.
You use the money you borrow in the new loan to pay off the old loan. That leaves you with just one loan, ideally with a better interest rate, lower monthly payment, or other improvement over the old loan.
Here’s a quick example. Let’s say you owe $14,000 on your car loan with an interest rate of 9.5%. You check out refinancing options and see you qualify for a rate of 5.5%.
When you refinance you borrow $14,000 with a rate of 5.5% then use that $14,000 to completely pay off the existing loan with a rate of 9.5%.
You’ll pay a lot less in interest paying 5.5% interest instead of 9.5% – good work!
If you’re curious about some more specific types of refinancing, and why it might not always be a good idea, check out our articles about student loan refinancing and home (mortgage) refinancing.