The good news is that there’s a way you may be able to save money and pay off your debt more easily. How? By refinancing your loans.
While refinancing has many benefits, it also has its risks. So how do you know if refinancing is right for you?
Here’s everything you need to know to help you decide.
What is refinancing?
Refinancing is the process of taking out a new loan to pay off your existing loans. The goal is to lock in a lower interest rate and better loan terms.
Doing so can decrease your monthly payment and the amount of interest you’ll pay over the loan term.
For example, let’s say you have a $250,000 30-year mortgage and refinancing your loan results in a 0.5% interest rate reduction. Your monthly payment would decrease by $75 and you’d save $27,000 in interest.
If you refinanced to a 15- or 20-year mortgage, you’d save even more money, but your monthly payments would increase.
Will refinancing always save you money?
Although refinancing is a great tool to help you save money, refinancing could sometimes end up costing you more. If you extend your loan term, you’ll pay more in interest even if your rate is lower.
For example, let’s say you have a $30,000 auto loan payable over 48 months. If you refinance loans and extend your loan term to 60 months, you’ll end up paying an extra $900 in interest.
What’s the process to refinance a loan?
Refinancing a loan is similar to the process you went through to get your original loan.
When you refinance loans, you should:
- Find out where you stand. Start by checking your credit score and reviewing your finances.
- Shop around. Shop around and get prequalified to see what kind of offers you can get without hurting your credit score.
- Compare your options. Compare lenders and loan terms to find the best deal.
- Apply. Complete a loan application.
Consumer debt refinancing
Personal loans and credit card debt are two of the most common sources of debt in the United States. According to the latest Report on the Economic Well-Being of U.s. Households (2016), 65% of households applied for a credit card in the last 12 months. Compare that to the percentage of households who applied for an auto loan (26%), a mortgage (10%) or a student loan (9%). Credit cards are the third largest source of debt after mortgages and student loans. The average family has $8,733 in credit card debt.
Debt refinancing involves moving loans or credit card balances from accounts with a high interest rate to one with a lower rate and better terms.
When done right, debt consolidation can help you save money in interest and repay your debt faster. For example, if you have two credit card accounts with a balance of $5,000 (23.49% APR) and $7,500 (21.49% APR) and pay it off with a 9.99% APR debt consolidation loan, you could save $5,744 in interest if you pay it off in 48 months.
Auto loan refinancing
Auto loan refinancing can save you quite a bit of money on your loan.
For example, let’s say you have a 60-month $30,000 loan. If you refinance loans to a 1% lower interest rate, you’ll save over $800 in interest.
Factors that determine your interest rate include:
- Your credit score.
- Your vehicle type and age.
- The lender you choose.
- The term length on your loan.
Auto loans by the numbers
Americans now have a total of $1.24 trillion of outstanding auto loan debt.
- New car loan average: $31,099
- Average monthly payment new car: $575
- Used car loan average: $19,708
- Average monthly payment used car: $378
Total outstanding auto loans:
When should you refinance an auto loan?
- Your credit has improved. With a higher credit score, you may qualify for a lower interest rate than when you first got the car loan.
- Interest rates have dropped. If rates have dropped due to market changes, refinancing your auto loan can help you save money.
- You’re struggling to make payments. You can lower your monthly payment by extending the loan term. This will increase the overall cost, though.
- You got a bad deal on your original loan. If you got a bad deal from the start, refinancing can help you get the rate and terms you deserve.
What to watch out for
If you refinance your loan and extend the loan term, you could end up upside down on your loan. That is, you could owe more than what your car is worth.
For instance, say your car is worth $9,000 and you refinance with an $8,000 loan over 60 months. Two years after refinancing your loan, you’ll still owe $4,900 on your loan.
If your car is only worth $4,000 at that point, you’d be upside down on your loan. So, if you tried to sell your car, you’d have to pay the lender $900 more than what you sold it for.
Here is a list of the benefits and the drawbacks to consider
- Opportunity to lower your monthly payment amount.
- Can save money by getting a lower interest rate.
- A lower payment could help you pay off the loan faster.
- If you opt for a longer loan term, you may end up paying more in interest.
- Refinancing for a longer loan term could put you at risk for being upside down on your loan.
How do you choose a lender?
When comparing lenders, pay attention to the interest rates and loan terms they offer. Use Supermoney’s auto loan engine to get prequalifed offers from various lenders.
Student loan refinancing
Just as with other types of refinancing, you can lock in a lower interest rate and save money when you refinance your student loans.
For example, if you have $35,000 in loans with a 10-year term and you decrease your interest rate by 2%, you’ll save over $4,000 in interest payments.
But beware: extending your loan term during refinancing can cause you to pay more in interest, even if your rate is lower. If you refinance that same loan but extend the term to 20 years, you’ll end up paying $7,000 more in interest than you would have had you not refinanced.
Student loans by the numbers
- Americans have $1.5 trillion in student loan debt.
- More than 13% of consumers have outstanding student loans.
- Average student loan debt per borrower was $34,144 in 2017.
Total outstanding student loans
When does it make sense to refinance your student loans?
Student loan refinancing can be a great option for borrowers who want to save money and lower their monthly payments, but that’s not the only reason to refinance.
You might also consider refinancing if:
You have multiple loans.
Refinancing allows you to consolidate all of your student loans into one, with a (hopefully) lower interest rate.
You want to remove a cosigner.
While in school, many student borrowers aren’t able to qualify for a loan on their own. To get a loan, you may need a parent or a friend to be a co-signer. This co-signer will be liable for the loan if you stop making payments. Once you refinance to a loan without a cosigner, your old cosigner will no longer be liable.
You want to add a cosigner.
On the flip side, you may want to add a cosigner to help you land a better deal. Most student loan refinancing lenders require solid credit to be approved. If you apply with a cosigner who has a great credit history, you’ll have an easier time qualifying for the best interest rates. But make sure you choose a lender that offers a cosigner release.
You want to lower your monthly payments.
If you’re struggling with payments, you can lower the monthly amount by refinancing with a longer term. But remember, a longer loan term means you’ll make more payments and pay more in interest over the life of the loan.
What to watch out for
While student loan refinancing is a great option to help save money, it’s not right for everyone.
If you’re considering refinancing federal student loans, find out what benefits or protections you might lose by doing so.
Here is a list of the benefits and the drawbacks to consider when refinancing student loans.
- Lower monthly payments.
- Lower the total amount of interest paid.
- Consolidate multiple loans into one.
- Add or remove cosigners.
- You could lose out on federal protections or benefits.
How do you choose a lender?
If you’re ready to refinance your student loans, review lenders and compare terms side-by-side to find your best deal.
Home mortgage refinancing
Home mortgages represent the largest component of household debt in America—$9.43 trillion, to be exact.
There are two types of mortgage refinance loans: rate-and-term and cash-out.
With a rate-and-term loan, you’ll get a new loan with a lower interest rate and better term.
Make sure you don’t inadvertently extend your loan term, though. For example, if you originally had a 30-year loan and, after 10 years, you decide to refinance it to another 30-year loan, you’ll end up paying more in interest.
Why? Because you are now making 40 years worth of interest payments.
A cash-out refinance allows you to borrow against the equity in your home. You’ll refinance your mortgage for more than what you owe on your house and receive the difference in cash.
You can use the additional cash any way you’d like. For example, you can use it to fund a home improvement project or pay off other debts.
Watch out for fees
Unlike auto and student loan refinancing, there are several fees associated with a mortgage refinance, such as:
- Application fee
- Loan origination fee
- Appraisal fee
- Inspection fee
- Closing fee
- Title search fee
- Survey fee
- Prepayment fee
If these fees are higher than what you would save in interest, it might not make sense to refinance.
Here is a list of the benefits and the drawbacks to consider when refinancing your mortgage.
- Lower interest rate.
- Lower your monthly payments.
- Convert an adjustable-rate mortgage to a fixed-rate
- Remove someone from the loan.
- Borrow against your home’s equity.
- Extending your loan term could cost you more money.
- Could be denied if your credit or income has dropped.
- High fees and costs.
How do you choose a lender?
Your original lender might not be your best option for refinancing. Be sure to shop around using SuperMoney’s mortgage refinance review page.
Final thought on whether to refinance loans
Refinancing debt is a great option for people who want to lower their payments and save money on interest. But there are some drawbacks, so make sure it’s right for your situation before you apply for a new loan.
Andrew is the managing editor for SuperMoney and a certified personal finance counselor. He loves to geek out on financial data and translate it into actionable insights everyone can understand. His work is often cited by major publications and institutions, such as Forbes, U.S. News, Fox Business, SFGate, Realtor, Deloitte, and Business Insider.