The average U.S. household now carries almost $8,300 in credit card debts. In total, American consumers owe over $1 trillion in credit card debts. Student loans are even higher, at a staggering $1.5 trillion.
In total, the average Joe or Jane now has a personal loan debt amounting to $38,000. That doesn’t even include what they still owe on their mortgages.
But that doesn’t mean there’s nothing you can do about it. Refinancing debt is one way to regain control of your loans and your finances.
What exactly does “refinancing” mean and what does it entail? Is it the perfect solution for everyone?
Keep reading then, as we’ll give you the lowdown on debt refinancing!
What It Means to Refinance Your Loans
Refinancing is when you trade an existing loan for a new loan or change the terms of your current loan. You can refinance common types of installment loans, like mortgage and auto loans. But you can also do this for other installment loans (such as personal loans) and even your credit card debts.
You can “swap” your current loans for new ones with the same or a different lender. Let’s say your credit score went up. In this case, you’d want to refinance your mortgage with the same lender for better terms.
You can also refinance to take advantage of better and lower current interest rates. You may even take out a new loan and use that to pay off your current debts. These two you can do with your current or another lender.
Why Refinancing Debt Makes Sense
The main reason to refinance debts is to cut your loan expenses as much as you can. Refinance right, and you can save a lot of money over the life of all your loans. With refinancing, you can get either a lower interest rate or be able to pay off your loans faster.
The Best Time to Refinance Your Debts
Securing a lower interest rate with a new loan is one of the many situations a refinance makes sense. A debt refinance program is also a good idea to reduce your monthly loan payments.
Note that not all lenders offer refinancing on their products though. But even if yours doesn’t, you can still refinance with another lender.
Below we’ll explain the best times to consider a debt refinance program. These apply to most loans, like mortgages and personal installment loans.
To Get Lower Interest Rates
Consider refinancing if there are lower interest rates available.
Let’s say you currently have a 30-year mortgage with a fixed interest rate of 4.51%. Then, while browsing the web, you find out that 15-year mortgages at the moment only have a 3.99% interest rate. That’s a considerable 0.52% difference, which can mean thousands of dollars of savings!
The same goes true for installment loans. If there’s any way you can pay off your loans early to save money, grab that opportunity. This can mean changing your current loan’s 12-month term into a 9- or 6-month term.
But first, make sure that you can afford the higher monthly payments of a shorter loan term. If your current and projected finances can afford this change, then consider refinancing.
To Lower Your Monthly Payments
If you’re strapped for cash — and will be for an unknown length of time — refinancing into a longer-term loan can help. For example, you can refinance a 15-year FRM into a 30-year FRM. Since you’ll have 15 more years to pay off your debt, then your monthly payments will also be lower.
Debt refinancing of personal loans follows a similar process. You can arrange for your current loans to have a term extension. If the lender approves, then your “new” loan will come with lower monthly payments.
If You Simply Want to Pay Off Your Debts Sooner
Did you know that on average, a U.S. debtor passes away still owing $61,000 in various kinds of loans? This poses a problem if someone else co-signed your loan, as they’d have to pay off your share too. There are also some states where surviving spouses have to pay off debts left by their spouses.
That said, you’d want to pay off your loans while you’re still alive and kicking. Refinancing allows you to get a new loan with a shorter term, so you can repay your debts sooner and faster. That way, you don’t leave your co-signers or your family members with your debt.
But before you refinance to a shorter-term loan, check your current loan’s rules first. Some loans, like personal installment loans, come with early payment penalties.
To Remove a Co-Signer from Your Loan
Speaking of co-signers, refinancing lets you remove their name from a loan contract. Let’s say you took out a personal loan with a co-signer, or you had your student loan co-signed by your parents. Either way, you now want to free them of the financial responsibility of being a co-signer.
You can opt for debt refinancing in this case. This’ll let you change the contract terms so that you’ll hold sole responsibility of the loan. So in case something happens, your lender doesn’t have a co-signer to pursue.
For Debt Consolidation
Debt consolidation is one type of refinancing, wherein you get a huge loan and use that to pay many loans. That single loan will “consolidate” or combine several loans into one. Because there’s only one loan, then that means you’ll make only one payment every month.
Many debt consolidation loans come with longer terms and lower interest rates. Most people opt for this refinancing method so they make their loan payments simpler. Many others go for debt consolidation so they can cut back their interest payments.
Sounds great, right? Before you get all excited though, be sure to first check the loan’s upfront fees and terms. Sometimes, consolidation loans can be more expensive than all your loans combined.
Is Refinancing Always a Great Solution?
Like with every other loan, refinancing isn’t a one-size-fits-all solution. Before you sign the dotted line on a new loan contract, consider these factors first:
Your Goals behind Refinancing
The main reason to refinance is to save on interest payments or to make monthly loan payments easier. If your goal, however, is to refinance to borrow more money for a “want”, you may want to re-think your decision. Instead, explore your other financing options first, or better yet, just save up the money.
The Interest Rate of the New Loan
Even if you’re refinancing to have a longer time paying off your loan, be sure the new interest rate isn’t higher! Lower is always best, but if not, then it should at least be the same as what you’re paying for with your current loan.
How Much You Still Owe on the Existing Loan
Let’s say you’re thinking of refinancing to secure a lower interest rate. True, a lower interest rate can save you a lot over the life of your loan and also make it easier to make monthly payments.
But this won’t make much sense if you only have little left on your current loan. Or if you’re about to finish paying off the loan within several months.
In this case, extending your loan terms can actually lead to higher total loan costs. Or, even if it’ll be break-even, refinancing in this situation will only lengthen the time you’re in debt. If you don’t have problems paying off your debts with their current terms, there’s no need to refinance.
Can You Afford the Changes?
On the flipside, refinancing to pay off debts sooner means higher monthly payments. So, ensure first that your budget can afford that increase.
Costs Associated with the New Loan
Refinancing isn’t “free”, as it comes with upfront fees like closing costs. Take a look at your finances and see if it can afford this one-time (but often expensive) payment. If it can and you won’t be in danger of missing deadlines on other loans, then go ahead and refinance.
Also, it may be best to deal with closing costs with an out-of-pocket payment. If you roll over these costs into your loan balance, the interest rate will also apply to them. This can wipe out the potential savings you get from refinancing.
Be sure to check that your current loan doesn’t have prepayment penalties too! And if it does, it shouldn’t be more than what you can save with the new loan. Otherwise, this’ll only defeat the purpose of saving money through refinancing.
Refinance Only When It Makes Sense
As you can see, there are many ways wherein refinancing debt makes sense, especially to save on loan costs. But it’s not for everyone, and not everyone can qualify for a refinance program. If you do qualify, make sure you’re still getting loan terms much better than your old loan.
Need more tips that’ll help you deal with credit card debts? Then be sure to check out our ultimate guide on balance transfer cards!