Refinancing: Purpose & Types

Definition

Refinancing in business and finance refers to the process of replacing or restructuring existing debt or financial instruments with a new arrangement.

What is refinancing?

Refinancing is a strategic financial decision often undertaken to optimise a company’s capital structure and enhance its overall financial health.

Purpose of refinancing:

Lowering interest rates: One common reason for refinancing is to secure a lower interest rate, which can lead to reduced interest expenses and increased cash flow.
Extending maturity: Refinancing can involve extending the maturity of existing debt, allowing a company more time to repay its obligations.
Changing terms and conditions: Refinancing may allow a company to negotiate more favourable terms, such as lower covenants or improved flexibility.
Consolidating debt: It can involve combining multiple debts into a single, more manageable instrument, simplifying the company’s financial obligations.
Risk management: Refinancing can be used to convert variable interest rates to fixed rates, providing protection against potential interest rate hikes.
Raising additional capital: In some cases, a company may use refinancing to raise additional capital by leveraging its existing assets or securing new funding sources.

Types of refinancing:

Debt refinancing: This involves replacing existing debt with new debt, often with more favourable terms.
Mortgage refinancing: In the context of real estate, this involves replacing an existing mortgage with a new one.
Equity refinancing: This involves restructuring equity ownership in a company, which might include issuing new shares or buying back existing ones.

Refinancing can involve various costs such as origination fees, legal fees, and other transaction expenses. These need to be weighed against the potential benefits. Furthermore, the company’s creditworthiness and financial performance are crucial factors in securing favourable refinancing terms.

Refinancing can lead to changes in the company’s financial statements, including the balance sheet, income statement, and cash flow statement. For instance, it might lead to changes in debt levels, interest expenses, and cash flows.

Not sure whether you should refinance? With our refinance calculator you can estimate the savings and costs associated with refinancing.

Example of refinancing

Company XYZ has an existing loan with a bank at an interest rate of 8% per annum. However, due to changes in market conditions, interest rates have decreased since the time the loan was taken out.

To take advantage of lower interest rates and reduce its interest expenses, Company XYZ decides to refinance its existing loan. It approaches several banks and financial institutions to negotiate a new loan with a lower interest rate.

After evaluating various offers, Company XYZ secures a refinancing deal with a new lender at an interest rate of 6% per annum. The new loan terms are favourable, offering lower monthly payments and reducing the overall cost of borrowing for Company XYZ.

If you want to learn more about refinancing, read our comprehensive guide today