In India, people often take loans for different reasons—buying a house, paying for education, or even covering daily expenses.
Imagine that you took a personal loan in Mumbai last year with a high interest rate, but today, interest rates have dropped. This is where loan refinancing can help.
Refinancing, say financial planners, can be done in both good as well as bad times. So it doesn’t matter if interest rates or real estate prices are rising or falling.
What is loan refinancing?
Loan refinancing is when you replace your old loan with a new one, often with a lower interest rate or better terms. This can help reduce monthly payments and save money.
Fact: If the loan tenure is extended when a borrower is nearing retirement, it can help reduce the monthly EMI burden, making repayment more manageable during the post-retirement phase.
Let’s understand it with an example:
Rina took a personal loan in Mumbai last year for ₹ 3,00,000 at an interest rate of 12%. Her monthly EMI was ₹ 28,000 for 12 months. Today, interest rates have fallen to 8%. If she refinances her loan, she can get a new loan with a lower interest rate.
Before Refinancing:
- Loan Amount: ₹ 3,00,000
- Interest Rate: 12%
- EMI: ₹28,000
- Tenure: 12 months
After Refinancing:
- Loan Amount: ₹ 3,00,000
- Interest Rate: 8%
- EMI: ₹25,000
- Tenure: 12 months
By refinancing, Rina can save ₹3,000 per month and also pay less overall interest.
Pros of Loan Refinancing
Lower Interest Rates
When interest rates fall, refinancing allows you to get a better deal.
Just like Rina, if you can get a lower rate than your current loan, your monthly payments will decrease, and you’ll pay less in total.
Reduced Monthly Payments
Refinancing can help lower your monthly payments, especially if you extend the loan tenure. This can free up money for other needs, like saving or investing.
For example, if Rina extends her loan term from 12 months to 18 months, she could further reduce her EMI to ₹20,000.
Access to Extra Cash (Cash-out Refinancing)
If you need extra money for emergencies or big expenses, cash-out refinancing allows you to borrow more than you owe on your existing loan.
For example, if Rina needs ₹ 50,000 for a family function, she can refinance her ₹ 3,00,000 loan to ₹ 3,50,000, getting an extra ₹ 50,000 in cash.
Better Loan Terms
Refinancing lets you change loan terms, such as switching to a fixed rate or shortening the term for quicker repayment.
Simplified Payments
Refinancing can consolidate multiple loans into one, simplifying management with a single monthly payment.
Cons of Loan Refinancing
Fees and Charges
Refinancing comes with fees like application, administrative charges, or prepayment penalties, ranging from 1-5% of the loan amount.
Longer Repayment Period
Extending the loan term lowers EMI but increases total interest. Rina might save ₹3,000 monthly but pay more overall.
Short-Term Drop in Credit Score
Refinancing may slightly lower your credit score temporarily, but it usually recovers over time.
Loss of Special Loan Features
Refinancing may result in losing special features, like a grace period. Check if these benefits are important before refinancing.
Risk of Borrowing Too Much
Cash-out refinancing may tempt you to borrow more than needed, leading to increased debt and future financial stress.
Pros and Cons Summary
| Feature | Pros | Cons |
| Interest Rates | Can get a lower rate | Could have extra charges or fees |
| Monthly Payments | Lower payments can free up money. | May end up paying more interest overall |
| Loan Terms | Ability to change loan terms | Might lose special features or benefits |
| Access to Cash | Can get extra cash if needed | Risk of overborrowing |
| Simplified Payments | One loan to manage, less stress | May be tempted to borrow too much |
Conclusion
Loan refinancing can lower interest rates, reduce payments, and provide extra cash. However, consider fees, longer terms, and potential credit score impacts before deciding.
Rina refinanced her personal loan in Mumbai, saving ₹3,000 monthly, which improved her finances. However, she had to consider fees and whether extending the loan term would lead to higher long-term costs.
In conclusion, refinancing can be helpful if you understand its pros and cons. Research and consult an advisor before deciding.