What exactly is “refinancing”?

After a couple of weeks talking about IRAs we’re moving on to another question. And this is a good one. “What is refinancing? I hear people talking about refinancing their home, their student loans, but what is refinancing and how does it work?”

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.