Interest-Only Refinancing

• An interest-only approach trades a conventional loan on which the borrower pays only the interest charged each month. The principal balance of the loan does not decrease and remains outstanding. This type of loan provides financing to hold onto an asset without any gain in equity. The approach is typically used when the buyer intends to hold onto the financed asset only for a short while and then sell it. This sort of loan was common during the real estate boom between 2006 and 2008.
  
  

Lowering Interest

• Refinancing to a loan with a better interest rate is quite common when interest rates drop significantly from historical levels. Borrowers who have old loans can refinance or get a new loan for the outstanding amount at a lower interest rate from a different lender. The old loan gets paid off and the new loan charges less per month. The borrower can then pay down the loan faster by putting more money toward principal or having a lower monthly amount due, improving cash flow. However, borrowers trading a fixed-rate loan for a variable-rate loan, even if the initial rate is lower, should be careful that they don't end up paying more over the long term.
  
  

Changing the Life Period of the Loan

• Another common refinancing approach is to shorten the life of a loan. This happens in real estate when the borrower may originally have a 30-year loan, for example. Rather than waiting the duration of the loan, the borrower may want to pay it down faster. Refinancing trades the old loan for a new one with a shorter time period for payments, such as 15 years. The trade-off is that the monthly payment amounts typically increase, creating higher demands on cash flow.
  
  

Variable Versus Fixed

• Variable-rate loans attract borrowers because their initial interest rate tends to be much lower than fixed loans. However, interest rates on these loans fluctuate with a market index, and may shoot higher within a few years. Those wanting out of variables when the cost goes up usually try to convert to a fixed-rate loan through refinancing. If a willing lender can be found, the old loan is paid off and a new loan with a stable, fixed rate (usually higher than the initial variable amount) is applied for a set payment period.
  
  

Peer-to-Peer Lending

• For those who want lower rates or can't find a loan package they like, peer-to-peer lending has become an alternative. With this approach, the borrower applies for a new loan to pay off an existing one. His credit score is rated by an Internet company that acts as a broker. Numerous other parties then evaluate his application and agree to fund small or large portions of the refinancing loan. When enough parties aggregate their funds to meet the loan need, the borrower is funded with a new loan to pay off the old one. For the borrower, the funding can be applied to a car, home, loan payoff or other needs. However, few restrictions protect peer lenders from default. The risk for investment loss varies depending on how large a portion of a loan a peer has funded. Peer-to-peer lending works well only to the extent that all parties involved follow the plan.
  
  

Cashing Out

• One method of refinancing that was quite common in real estate until 2008 with the U.S. economic downturn was cashing out. In this refinancing approach, a new loan is created to pay off an old one, but with a home's increased value, money is generated. The borrower takes out a bigger loan than before and takes some of the money for personal use. The collateral for the new loan becomes the increased value or equity in the house. However, when the real estate market falls, the home typically goes "underwater," worth less than the loan balance. Cashing out further is then barred, because no lender will refinance a home that's more than 100 percent financed already.