When you go to eat outside in a restaurant and you get a deal where there is discount of 10 percent on the amount of total food bill you would obliviously will be happy, in the same way in finance when a lender revises the loan terms by offering either a revised payment schedule resulting in extension of maturity or lowering the rate of interest on loan it is called refinancing. Given below are the advantages and disadvantages of refinancing –
Advantages of Refinancing
- When an individual is in financial stress and if he or she manages to get his or her loan refinanced then he or she is saved from getting declared insolvent or becoming defaulter of loan and as we all know that when an individual become defaulter his or her credit score gets affected and it leads to problems in future because it’s like a big red mark on your report card and any finance company or bank will think 10 times before giving you loan due to your previous bad record.
- In monetary terms also refinance is good because majority of lenders while refinancing reduces the rate of interest on loan and therefore as borrower you have to pay less interest than before and hence it leads to saving of money from borrower point of view.
- From the point of view of lender also refinance is advantageous because it is very difficult to get money from people who are in financial stress and even if lender has secured loan then also it is difficult to sell that security immediately and hence refinance in a way helps lender from undue stress arising out of default on the part of debtor.
Disadvantages of Refinancing
- The biggest disadvantage of refinancing is that as a borrower you have to abide by the terms set by lender and hence lender plays the role of deal maker and you have no option but to accept the terms of refinance as decided by the lender.
- Another disadvantage of refinance is that in majority of cases the lender of loan extends the loan period which is always a dangerous thing because majority of people like to repay their loan as quickly as possible because nobody wants to be in constant burden of debt but in case of refinance of loan this option is taken away from the borrower.
- As a lender refinance is disadvantageous because as a lender in case of refinance either you have to lower the rate of interest on loan or extend the debt period and in both the cases lender stands to lose because of as time period increases time value of money comes into play leading to lower real rate of return for the lender.
As one can see from the above that refinance has both advantages as well as disadvantages and majority of lenders don’t want to refinance their loans but when their no option left then refinance is useful and advantages from the point of view of both lender and borrower.