When a person takes out a loan, the loan usually is issued with specific terms, such as the rate of interest the person must pay on the principal and when the loan must be repaid. Similarly, a bill may also carry interest or have a specific repayment schedule. If the debtor chooses to replace this debt with another debt -- one with different terms -- this process is known as refinancing.
Refinancing
A debt is considered to be refinanced when the debtor's current debt is paid off and the debtor takes on a new, replacement debt. Often, a debt will be refinanced by a different lender than the one that issued the previous debt. This lender is essentially buying out the previous loan in exchange for the right to be repaid for the new loan he issues to the debtor.
Reasons
The refinancing process is initiated by the debtor for a number of reasons. Refinancing is most often done with houses, although it also can be done for cars and other sizable loans. Generally, the debtor refinances to gain some financial advantage. For example, the debtor may seek to refinance into a loan with a smaller monthly payment amount or a loan with a lower rate of interest.
Modification
In lieu of refinancing a loan, a debtor may seek to change the terms of his current loan. Instead of entirely replacing his current loan, the debtor and the lender instead sign an addendum to the current loan contract that changes its terms. Unlike refinancing, loan modification must be completed with the permission of the current lender. Refinancing can be pursued with the approval of the debtor only.
Considerations
Most debts are transferable, both by the buyer or the seller. This means that, theoretically, a debtor can refinance nearly any debt, as long as he finds a seller willing to buy his debt and issue him a new one. However, realistically, many lenders may be unwilling to pay a person's debt and issue him a new one. In addition, some debts carry financial penalties for early repayment.
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