i understand people do it for lower interest rates but how does that benefit the bank/company?
In: Economics
You win by getting a lower rate, thus saving money
Bank wins by getting more clients, thus making more money
I’m sure someone with a lot more brains than me will answer it better than that lol.
Refinancing means taking out a new loan to repay the old loan.
Banks charge fees to do this. Typically thousands of dollars to process and approve a new loan. Many banks and nearly all small banks don’t make money from interest on loans. Most of the money they make is on loan fees and charges.
And banks are generally in a competitive market – if they don’t refinance loans, another bank will. Even if the original loan is with Bank A, Bank A will typically still agree to refinance the loan because they know that Bank B is just around the corner.
Refinancing involves *two* banks – the bank you currently owe, and the bank you are refinancing with.
Let’s say you owe 100 grand to Bank A, at a rate of 10% per annum. The terms of the loan say that you have to pay it off within 20 years from now **but you can pay it off earlier**. So, you go to Bank B and you get *them* to loan you 100 grand at 4%, and immediately use that money to pay off your loan to Bank A.
This is how refinancing works. You get someone *else* to lend you the money, and use their loan to pay off the original loan. You benefit from the lower interest rate, and Bank B benefits from being the ones to collect that interest. It doesn’t benefit Bank A, but there’s usually not much they can do to stop it – some loans place restrictions on early payment, but if your loan doesn’t, it’s all good.
It’s usually easier to refinance a loan than it is to get a new loan. Banks usually need to assess your finances, take a look at how much money you owe and whether you’ll be able to pay back your debts with the new loan. If you went to Bank B and just asked for 100 grand, they’d have to ask whether you’ll be able to pay back the loan from Bank A *and* this new loan. But if you tell them you’re using the loan to pay off Bank A, then they can ignore that loan. Of course you’ll be able to pay back Bank A, that’s the point of the loan.
It costs money to originate a new loan, the new bank benefits from that. Your original bank gets a benefit as the old loan is paid off now, vs payments over X years (eg would you rather have $100 now vs $11 a year for 10 years).
You have two friends, Bob and Charlie. Charlie owes Bob $1000 and he promised that he would pay Bob 6% interest on that money.
You tell Charlie that if he gives you $20, you’ll loan him $1000 to pay off Bob, and he only has to pay you 5% interest on that money instead.
Bob is aware of this, so he might decide to match your offer and also offer Charlie 5% interest instead, because he’d rather Charlie pay him 5% interest than no interest at all.
It doesn’t benefit the bank holding the current mortgage. But you’re free to pay off your mortgage at any time. When refinancing, you find a new lender to give you a new mortgage loan, which is used to pay off the old mortgage loan.
Latest Answers