Ever been in urgent need of cash or in a financial crunch, and taken high-interest loans? Sometimes multiple such loans? If this is you or someone you know, this blog is for you.
Understanding Loan Refinancing and Its Benefits
The interest burden from these loans start to pile up, adding financial and mental stress. Most people think they have no options but to see these loans through. However, if you can get a more affordable loan, you can take it and pay off these other loans. The act of loan refinancing is replacing an existing loan with one with much better terms. Whilst the principal amount will have to be paid back in full, if done correctly, refinancing can save you a lot of money in interest over the long run.
The main benefit of loan refinancing is that your interest burden goes down, resulting in your monthly payments being much lower, freeing up cash for other expenses. You could also direct these extra funds toward quicker repayment of the loan.
Is Loan Refinancing Possible in Your Circumstance?
Not all loans can be easily refinanced, and it is important to understand your options in India.
- Switch lender for the same loan: Loans that can often be refinanced include home loans, education loans, and personal loans. However, each type of loan comes with its own set of considerations and requirements for refinancing. For example, home loans often require a certain percentage of equity in the property before refinancing can be considered.
- Renegotiate loan terms with your existing lender: It is also important to explore alternative options to loan refinancing, such as loan restructuring or renegotiating the terms of your existing loan. Often lenders are willing to reduce their rates if they know you could get a better deal from another bank.
- Get a secured loan to replace unsecured or informal loans: For those with informal loans or unsecured personal loans from NBFCs, renegotiation or switching lenders may not be an option. In this case, taking a different type of loan - a secured loan - to pay off the high interest loan is a good solution. Using your other financial assets, such as a life insurance policy, FD, PPF or PO savings, to get an affordable secured loan instead is usually a great option.
Factors to Consider Before Refinancing Your Loan
While we have determined that loan refinancing is a good option, there are a set of factors that you should take into consideration to make this option benefit you.
- Interest rate on your loan: Check the interest you are paying against current market rates. Only if there is a significant difference in the rates does it make sense for you to pursue loan refinancing.
- Loan tenure: Refinancing is also a great way to either increase or decrease the tenure of your loan. Depending on whether you are trying to shorten the payback period of the loan or increase it, check the terms of the loan and ensure it aligns with your objectives. A longer tenure could reduce the monthly EMI, for example, but increase the amount you pay in interest overall.
- Check the fine print: Receiving a loan comes with other charges that may not be obvious, such as application fees, processing fees, legal fees, and valuation fees. It's essential to carefully consider these costs and determine if they outweigh the potential benefits of refinancing. Look out for any hidden costs.
- Your CIBIL score / credit score: Before any lender refinances your loan with another loan, they will first evaluate your credit score. If your credit score has increased since you received your first loan, this could indicate good repayment practices to the lender and increase the likelihood of your loan being approved, and vice versa for a decline of your credit score. The only exception to this could be when refinancing your unsecured loans with a secured loan against a financial asset.
If you have taken informal loans to date, and/or do not have a credit score yet, explore refinancing with a secured loan. Policy loan, gold loans, loans against mutual funds, loans against PF etc, utilise the asset value as collateral, and thus credit score and income proof are less critical factors. Check out our Sahi Secured Loan Tool to find the options best suited to your context.
The Impact of Loan Refinancing on Your Credit Score
Before refinancing, it's essential to review your credit report for any errors or inaccuracies. Disputing and correcting these errors can help improve your credit score and potentially qualify you for better loan terms at the time of refinancing.
Refinancing a loan involves applying for a new loan, which means that the lender will conduct a hard inquiry on your credit report. This can temporarily lower your credit score. However, this impact is usually minimal and temporary, especially if you have a good credit history.
If you consistently make timely payments on your refinanced loan, it can have a positive impact on your credit score over time. On the flip side, if you default on your refinanced loan or make late payments, it can have a highly negative impact on your credit score. Therefore, it is crucial to carefully consider your financial situation, budget, and repayment capabilities before opting for loan refinancing.
Refinance Effectively to Improve Financial Wellness
After successfully refinancing your loan and securing a lower interest rate, it's important to utilize the savings effectively. Here are some tips on how to make the most out of your refinancing:
- Prioritise Higher-Interest Debts: Credit cards or personal loan debt should be paid off first from any loan refinancing. Doing this reduces the total interest you pay instantly.
- Try to Reduce Loan Term: Making additional payments towards your loan principal can help you pay off your loan faster and save on interest in the long run. Check with your lender if there are any prepayment penalties before making additional payments.
- Increase your Financial Safety Net: If you have the ability through refinancing, start to build an emergency fund or contribute to a retirement account or a diversified investment portfolio.
Finally, good luck with renegotiating with your lender or finding an alternative lender to refinance your loan! If refinancing an existing loan using other financial assets such as your life insurance policy please reach out to us on WhatsApp and Mera Kal is happy to help. Remember, it’s important to be responsible about borrowing, so we will work with you to ensure the loan amount aligns with your repayment capabilities and is genuinely a better option than other alternatives for you.