Overview
Refinancing can be a powerful financial strategy, especially if you’re looking for a way to take control of your debt. Whether you have a mortgage, personal loan, auto loan, or student loan, you may leverage it to simplify the repayment process and potentially save on interest. Let’s take a closer look at what refinancing is so you can decide if it makes sense for your unique situation and long-term goals.
Key Takeaways
Refinancing replaces your existing loan with a new one, ideally with a lower rate or better term for your needs.
While this strategy can streamline loan repayment and reduce overall interest costs, it often comes with fees and requires good to excellent credit.
A refinance might be worthwhile for a variety of loan types, such as mortgages, personal loans, home equity loans, auto loans, and student loans.
What is Refinancing?
When you refinance a loan, you take out a new loan and use the proceeds to repay one or more existing loans. The primary goal of this strategy is to improve your terms, either through a lower interest rate, shorter or longer term, or a different type of rate. You may also be able to access cash or switch to a more attractive lender.
What Types of Loans Can You Refinance?
Although you can refinance almost every type of consumer loan, the most common ones include the following:
Mortgages
Whether you have a conventional or government-backed mortgage, such as an FHA, VA, or USDA loan, you might be able to refinance it. This strategy may be worthwhile if you want to lower your interest rate or switch to a different loan type or rate structure.
Home equity loans/home equity lines of credit (HELOC)
If you tapped into your home equity through a home equity loan or HELOC, refinancing can make sense. It’s worth exploring if you want to land a lower rate, shorten your term for a faster payoff, or lengthen your term to lower your monthly payments.
Personal loans
If you took out a personal loan to consolidate debt, cover an unexpected expense, or pay for a major expense like a home renovation, you may be able to refinance it. Refinancing can allow you to simplify repayment, lock in a competitive rate, or reduce monthly payments.
Auto loans
An auto loan refinance may be a sound strategy if you want better terms. It can result in a lower interest rate or smaller monthly payments. Refinancing your auto loan may also reduce its length, potentially saving you money in the long run.
Student loans
If you have federal and/or private student loans, you might be able to refinance them through a private lender. By doing so, you may secure a lower interest rate and streamline repayment. Note that if you refinance federal loans, you will lose protections, such as income-driven repayment plans and student loan forgiveness.
When to Refinance
There are many reasons to pursue refinancing, but here are several of the common motives for moving forward with this strategy:
1. Rates have dropped
If interest rates are lower than they were when you originally took out your loan, refinancing may significantly reduce your overall interest costs.
2. Your finances have improved
A higher credit score, lower debt-to-income ratio, or more consistent income stream might make you eligible for better terms than when you initially borrowed money.
Take Mary Smith, for example. When she first took out a mortgage, her credit score was low. Over time, however, she’s improved it. Mary also landed a better job with a steady paycheck. In Mary’s case, refinancing is a smart move. She’ll likely qualify for a lower interest rate, which can save her a great deal of money on the payoff process.
3. You prefer lower monthly payments
Extending your loan term through refinancing can lead to smaller monthly payments and give you some wiggle room in your budget.
4. You hope to pay off debt sooner
As long as your budget and income allow, a refinance into a shorter-term loan can result in a faster payoff and thousands of dollars in interest savings.
Tom Doe, for example, recently received a raise at work. He also wants to prioritize retirement and college savings for his kids. For Tom, refinancing from a 5-year personal loan to a 2-year loan is a solid choice, especially now that he has more funds at his disposal. He can afford the higher payments in exchange for a faster payoff.
5. You want to change your loan features
Whether your goal is to switch to a fixed or variable interest rate, or to find a lender with better customer service or hardship support, refinancing can help you tailor your loan to meet your needs.
Pros & Cons of Refinancing
Just like any financial move, refinancing has its upsides and downsides that are important to consider, including:
Pros
- Potentially lower interest rate: You may be able to qualify for a better interest rate than you’re paying on your current loan, especially if rates have gone down or your financial situation has improved.
- Smaller monthly payments: A lower interest rate or longer term may reduce your monthly payments, giving you some extra breathing room in your budget.
- Faster payoff: If you switch to a shorter term loan or land a lower rate, you might pay off your loan sooner than you ever thought possible.
- Access to a different lender: If you’re unhappy with your current lender or want to find one with better service, fewer fees, or more perks, refinancing may be worth it.
Cons
- Upfront costs and fees: Most lenders charge fees for refinancing, such as origination fees, closing cost, and prepayment penalties, all of which may eat into your savings.
- May require strong credit: If you don’t have good or excellent credit, it might be difficult to qualify for refinancing.
- No guarantee of a lower rate: While you might be able to lock in a better interest rate with a refinance, it’s not always possible.
- Hard credit check: If you apply for a refinance, the lender will likely perform a hard credit pull, which can temporarily lower your credit score by a few points.
How to Refinance a Loan
If you believe refinancing may be right for you, follow these six steps.
Evaluate your current loan: Make sure you know your loan balance, rate, term, and monthly payment.
Assess your finances: Check your credit score and understand your income and debt-to-income ratio so you have an idea of what types of refinancing offers may be feasible for you.
Shop around: Do your research and prequalify for refinancing with a few lenders so you can compare rates, terms, customer service, and perks.
Complete an application: Most lenders let you submit documents and formally apply for a refinance online.
Pay off your old loan: Unless your lender will do this for you, it’s your responsibility to use the proceeds of the new loan to repay your existing loan.
- Make payments on your new loan: Be sure to pay your new loan on time and consider autopay to ensure you never miss a payment.
Be Smart About Refinancing
When used strategically, refinancing can improve your finances and potentially save you a great deal of money and stress in the process. As long as you’re a good candidate and find an offer that meets your needs, it can set you up for a stronger, more confident financial future.
But don’t refinance just for the sake of it. Always check your specific situation before changing your loan.
by your friends at The Daily Navigator
