If you’re unhappy with your mortgage, car loan, or student loan, there is no reason to feel trapped by your current lender. Refinancing allows borrowers to take out a new loan and pay off the old one. The result may be a lower interest rate, better terms, or even the ability to walk away with cash in your pocket.
However, if done at the wrong time, refinancing could prove to be a costly mistake. To avoid a financial misstep, stick to the following seven guidelines for when the experts say it it makes sense to refinance.
1. When interest rates change. Interest rates are rising, you may want to think about refinancing variable rate loans. “Locking in a fixed rate is always a good idea,” says Brendan Coughlin, president of consumer loans for Citizens Bank.
Alternatively, if your mortgage is 20 years old, you could be paying a much higher interest rate than what is offered today. While you want to take advantage of low rates before they go up, it’s wise to consider whether refinancing will save you money.
2. When your credit improves. While interest rates don’t go down for everyone, they could go down for you if your financial situation improves. “Our view is that the day you graduate and get a job is the day you have to refinance your [student] ready, ”Coughlin says.
Stable income and a history of paying bills on time can lead to lower rates for various types of debt. Stephen Dash, founder and CEO of Credible, a platform that connects student loan borrowers with lenders, says people need to be careful not to forfeit any benefits when refinancing. he notes private student loan lenders may not have income-based repayment plans or participate in public service forgiveness programs.
3. When you want to reduce your payment. Families with tight budgets may find that refinancing relieves high payments. In many cases, this is achieved by extending the term of the loan. Borrowers should carefully consider whether the monthly savings are worth paying on debt for years longer than initially expected. “As a general rule, extending the loan term is undesirable if you are increasing the loan term by more than a few years,” says Kevin Gahagan, chief investment officer at Mosaic Financial Partners in San Francisco. This could mean paying thousands of additional interest over the life of a loan.
4. When you want to get out of debt sooner. Just as you can refinance to extend the term of a loan, borrowers can also refinance. shorten the term. While technically not refinancing, Coughlin says consolidating credit card debt into one personal loan is one way to shorten the repayment period. “You know you’re going to pay that $ 10,000 over three years instead of just paying interest [indefinitely],” he says.
5. When you need cash. Cash-strapped households may find they are able to draw on their equity when refinance a mortgage. Some banks may also consolidate credit card debt into a personal loan and include an additional payment to the borrower. While one should not take on debt lightly, refinancing for this reason can be useful to those who have exhausted other options.
6. When you want to simplify your finances. Dash says a lot of people choose to refinance their student loans to make their life easier. “On average, a borrower graduates with eight different student loans,” he says of his industry experience. By refinancing multiple loans into a single new product, people can streamline the process of paying off debt. It can also help minimize the risk of missed payments and late fees.
7. When it doesn’t cost you much. Refinancing can save money, but it is not free. There may be bank charges and other fees, especially in the case of mortgage refinancing. “Ideally, if there are closing costs involved, you want to be able to recoup [those] within 12 to 18 months of the loan origination, ”says Gahagan.
Cutting costs means examining the fine print and checking the rates of several institutions to make sure they justify the cost of refinancing. Many financial institutions offer instant quotes on their websites. Other sites serve as intermediaries to provide the rates of several lenders.
For borrowers, refinancing saves money, reduce monthly payments and provide a source of money. Be careful, however, not to pay too much for a loan that has too few benefits.