Refinancing Resets More Than The Interest Rate

Refinancing settles an existing agreement with a new one. The visible change is the rate or the payment, but the reset that comes with it affects several things at once.

The clock on the term restarts

A borrower two years into a five-year agreement who refinances into a new five-year agreement has returned to the start of a term, with three years of progress exchanged for a lower payment.

Total interest depends on how long the money is borrowed as well as the rate, so a lower rate over a longer period can still cost more overall.

The comparison that matters is the remaining total payable on the existing agreement against the total payable on the new one, not the two monthly payments.

Amortisation returns to its early shape

In a level-payment agreement, early payments are weighted towards interest and later ones towards principal. Refinancing moves the borrower back to the interest-heavy part of the curve.

The balance therefore falls more slowly at first than it did immediately before the refinance, even though the payment may have decreased.

Where the underlying asset depreciates, as with vehicle finance, this can extend the period in which the debt exceeds the value of what secured it.

Settlement costs sit inside the new balance

Early settlement of the old agreement may carry a charge, and the new agreement may carry arrangement fees. Both are commonly added to the amount borrowed rather than paid separately.

Adding them means they are financed at the new rate over the new term, which increases the total more than the headline figures suggest.

Rules governing early settlement calculations and the disclosure of fees vary between jurisdictions and between product types within the same market.

Reporting history restarts too

The settled agreement is reported as closed and the new one begins with no history. A long record of on-time payments becomes a closed account rather than a live one.

Closed accounts continue to appear for a period and continue to count, but the live picture now shows a recently opened agreement rather than an established one.

A new agreement also generates an application search, and the combination of a search and a newly opened account is read as a change in circumstances by later assessments.

Consolidation is refinancing with more moving parts

Replacing several agreements with one applies all of the above simultaneously, and adds the risk that the cleared facilities remain open and are used again.

Where the new agreement is secured against property and the old ones were not, the consequence of failing to pay changes fundamentally even if the arithmetic improves.

The arithmetic of a refinance can be sound. The point is that the rate is only one of the terms being replaced.