i understand people do it for lower interest rates but how does that benefit the bank/company?
In: Economics
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.
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