To refinance a loan, you take out a new loan, and pay off the old one with it. Obviously, the new loan should offer you improved terms over the old loan. If the old loan involved the use of collateral (assets you own that guaranteed the load), they can also be used for the new loan. Sometimes a borrower will borrow a little extra during refinancing to take some equity out of an asset (known as "cash out" refinancing).
A refinancing may also allow you to change the type of loan you are making, as you may wish to switch from a variable-interest rate loan to a fixed rate of interest.
In a refinancing it's important to take all the extras into account. There are often fees and charges that may make the refinancing not worthwhile. You should carefully compare the refinancing with your previous loan, looking at the full set of costs. A prepayment penalty on some loans, particularly car loans, is one to watch out for.
Many people refinance car loans to increase the length of the loan so as to reduce the size of monthly payments. They should realize, of course, that this increases the cost of the loans because more interest is paid – use the calculator to see just how this works.
You may also want to watch out for getting stuck with an "upside down" auto loan – this means a loan in which the car you own isn't worth as much as the loan you are paying off. If you increase the length of your loan, you should realize that your car will decline in value over the period that you pay off the loan. Late in the loan period, if you try to sell the car, you won't be able to recuperate as much as you owe the lender, and you'll have to spend your own money to pay off the loan.
But, for whatever kind of loan you may have, there may be good reasons to refinance. One is that interest rates may have sharply declined. If you borrowed in a period of high general interest rates, and they've since gotten lower, you might be able to arrange a good deal with a different lender based on the lower rates. Sometimes even the same lender will make such a deal, knowing that if they don't, you'll go elsewhere.
Another reason for refinancing may be that your credit score has improved. This means that you now have access to many better loan deals than you could get previously. You might have corrected errors in your credit scores, or simply gone for a period of caring carefully for your credit so that your scores improved.
When considering a refinancing, shop around. Talk to a variety of lenders, and use the calculator to compare their terms. Remember that, once you've made a refinancing deal, you'll have to live with it for a long time, so make sure you're happy with it.