Is refinancing your debt the right move?
When to refinance debt
- Refinancing replaces an existing loan with a new one carrying revised rates and terms.
- Consumer debt, student loans and mortgages all can be refinanced.
- Accurately compare rates, terms and fees between the existing and refinanced loans to avoid entering a worse arrangement.
Paying off debt can feel like running on a hamster wheel, particularly when the existing loans were taken out years ago. Fortunately, the rates and terms of a loan are not set in stone. Refinancing can help lower interest rates and monthly payments or revise loan terms by taking out a new loan to pay off the existing one.
Refinanced debt is not eliminated or lowered, but rather repackaged with preferably improved conditions to help you better manage and get out of debt faster. Refinancing also can be a method of debt consolidation. If you hold several different loans at varying rates and terms, refinancing can bundle multiple debts into a single monthly payment and potentially reduce your long-term interest expenditure.
Credit card debt and auto loans are ideal candidates for refinancing, because they typically carry very high interest rates.
Credit card debt can be refinanced through a credit card balance transfer — often offering 0 percent interest for an introductory period — or through a low-interest personal loan. Compare the rates and terms of both and consider negotiating with your existing lender to get the best deal.
Auto-loan refinancing is a good option for those with strong credit and equity in their car— in other words, owing less on the vehicle than its retail value. Because of risk-based pricing, in most situations an older car will carry a higher interest rate. Compare lender rates and terms to ensure that you are reducing long-term costs and not accepting lower payments for an extended term. Credit unions and traditional lenders both offer competitive interest rates on auto refinancing for borrowers with good credit.
Federal and private student loans are eligible for refinancing together or individually. Refinancing may be a particularly good option for high-interest private student loans obtained before the student had built substantial credit or for federal Parent PLUS parent loans — which can carry interest rates higher than private loans.
It is important to remember that once a federal student loan is refinanced or consolidated via a private lender, it is no longer eligible for Federal Direct Consolidation or other government-sponsored loan-repayment and forgiveness programs.
Mortgages are commonly refinanced as significant savings can be achieved if interest rates are lowered over a long period. There are four primary types of mortgage refinance loans: rate and term refinance, cash-in refinance, cash-out refinance and federal refinance.
- Rate and term refinance is the conventional refinancing method. An existing mortgage is replaced by a new one, ideally with improved rates and terms for long-term cost savings.
- Cash-in refinancing is when the homeowner pays down their mortgage to establish a certain level of equity in their home in order to be eligible for a refinance.
- Cash-out refinancing is a mortgage refinance for more than the amount owed. The difference is paid to the homeowner in cash.
- Federal refinance options include Federal Housing Administration, Veteran Affairs, U.S. Department of Agriculture and Home Affordable Refinance Program (HARP) loans that subsidize refinancing for qualified individuals.
With mortgage refinancing, it is important to assess the entire loan package and all associated origination, appraisal and closing fees, among others, which can add up to several thousand dollars. Typically, lowering a mortgage interest rate by 0.5 percent to 1 percent is considered sufficient to cover fees while still reducing costs in the long term.
As with any loan refinance, it is important to accurately compare the new loan term to the existing loan and overall financial plans. A retiree still paying a mortgage may find a term extension beneficial in reducing monthly payments to suit social security income, while a middle-aged individual several years into their mortgage may not want to enter another long-term loan.
Factors to Consider
If your credit strengthened since taking out your existing loan, you will likely be eligible for lower interest rates when refinancing. Those with low or poor credit should work on improving credit scores prior to applying in order to make the most of refinancing opportunities.
If you accepted a high interest rate consumer loan or broader interest rates have fallen since the initial loan was obtained, it may be prudent to refinance. Ensure that lower rates or payments, however, are not being applied to longer loan terms, which could increase your overall costs. Typically, an equivalent or shorter term is ideal when refinancing a loan.
Shop around to identify what refinancing options are available to you and consider negotiating with your existing to lender to see if they can improve rates and terms.