Refinancing

When you refinance, you take out a new loan and use it to pay off the old one. The main reasons are to reduce the interest rate, to lower monthly payments by spreading the debt over a longer period, to switch between fixed and variable rates or to borrow extra money against an asset such as a home.

The savings can be significant. On a 200,000 mortgage over 25 years, cutting the interest rate from 7% to 5.5% lowers the monthly payment from about 1,414 to about 1,228, a saving of roughly 185 a month.

Refinancing has costs, though. There may be arrangement fees, legal or valuation costs and penalties for repaying the original loan early. These need to be compared with the savings to see whether refinancing is worthwhile and how long it takes to break even.

Extending the loan term can also be a trap. Lower monthly payments may feel better, but stretching the debt over more years can increase the total interest paid, even at a lower rate.