Refinancing
Refinancing means the replacement of any current or present debt which is in existance with a debt with more attractive interest rate or with more favourable and different terms. The new loan funds are used to pay down the current mortgage and after this, any remaining amount can be used to debtor's best choice.
Generally refinancing is used for home mortgage.
If this replacement of debt comes under financial distress, it is also referred to as 'debt restructuring'.
Reasons
There might be many reasons why debt needs refinancing.
1. Debtor wants to take a better interest rate for him so that he may enjoy a lower monthly payment.
2. Debtor wants to alter risk. He might want to opt for fixed-rate loan rather than variable-rate loan.
3. Debtor wants to consolidate other debts into one single loan. Note down that it will be of longer term obviously.
4. Debtor wants to reduce his monthly repayment amount for his convenience. This will also result longer term.
5. Debtor wants to free up his cash. This will also result for longer term.
Among above reasons, reason no. 3, 4, 5 are usually taken by such borrowers who are in financial difficulty and so they want to reduce their monthly repayment installments. Though their term will be longer for this reasons.
Simple and Cash-Out Refinance
The difference between Simple and Cash-out refinacne can be understood by this example.
Example: Mr. Tom and Mr. Dick both took out a mortgage loan worth $500,000. After 5 years, both of them paid off $300,000. Mr. Tom then took out another home loan worth $200,000 to repay the existing loan balance. This is called Simple Refinance.
And Mr. Dick took out another mortgage worth $300,000 to repay the unpaid loan balance which is $200,000. Now Mr. Dick can use the remaining balance of $ 100,000 to fulfill other financial obligations. This is called Cash-out Refinance.
