Refinance: What It Is and How It Works

Definition

A refinance (or refi) replaces an existing loan with a new loan to obtain better terms — commonly a lower interest rate, different loan duration, or access to cash. The new loan pays off the old one; because it’s a fresh credit agreement, the lender re-evaluates your income, credit history, and the property or collateral.

Why people refinance

Common motivations:
* Lock in a lower interest rate to reduce monthly payments and total interest paid.
* Change the loan term (shorten to pay less interest, or lengthen to lower monthly payments).
* Switch between fixed and adjustable rates for predictability or potential savings.
* Tap home equity for cash (for renovations, debt payoff, etc.).
* Consolidate multiple debts into a single, lower-rate loan.
* Take advantage of an improved credit profile.

How refinancing works

1. Compare options from your current lender and other lenders.
2. Apply for a new loan; expect income and credit verification and an appraisal for secured loans.
3. If approved, the new lender pays off the original loan and issues the replacement loan under the new terms.
4. Consider closing costs and fees — they affect whether the refinance delivers net savings.

Note: Mortgage lending discrimination is illegal. If you suspect discrimination, you can report it to agencies such as the Consumer Financial Protection Bureau (CFPB) or the U.S. Department of Housing and Urban Development (HUD).

Common types of refinancing

• Rate-and-term refinance — Replace the old loan with a new one to get a lower interest rate or change the term.
• Cash-out refinance — Increase the loan amount to withdraw equity as cash; raises loan balance and often interest rate.
• Cash-in refinance — Pay down principal at closing to reduce loan-to-value (LTV) or qualify for better terms.
• Consolidation refinance — Combine multiple debts into a single loan with a lower average interest rate.

Pros and cons

Pros
* Lower monthly payments and interest costs if rates drop.
* Ability to switch to a fixed rate for predictability.
* Access to cash without selling an asset (cash-out).
* Opportunity to shorten the term and reduce total interest paid.

Cons
* Closing costs and fees can offset savings.
* Resetting to a longer term can increase total interest over the life of the loan.
* Cash-out refinancing reduces equity in the property.
* You may need to refinance again to capture future rate drops.
* Shorter-term loans raise monthly payments.

Example

Jane and John have a 30-year fixed mortgage; after 10 years they’re paying 8% interest. Rates fall and they refinance into a new 20-year mortgage at 4%. Their monthly payment decreases and they lock in lower interest for the remaining loan term.

Corporate refinancing

Companies refinance to restructure debt, lower interest costs, or improve balance-sheet metrics. Corporate refinancing can include replacing older bonds with new issues at lower rates or reorganizing loan terms; it’s also a tool used during debt restructuring when a company is under financial stress.

Does refinancing hurt your credit?

Applying for a refinance triggers a credit inquiry and may cause a small, temporary drop in your credit score. Over time, improved payment terms or reduced balances can help your credit. Mortgage lenders will re-evaluate your creditworthiness during the application process.

Bottom line

Refinancing can reduce borrowing costs, change loan terms, provide cash from equity, or consolidate debt. Whether it makes sense depends on current rates, closing costs, your remaining loan term, and your financial goals. Compare offers, calculate break-even points, and consider both immediate and long-term impacts before proceeding.