If you have some form of debt (student loans, car loan, mortgage, etc.), refinancing may have crossed your mind a few times. So what exactly does it mean to refinance? To refinance means to replace your existing debt agreement with a new debt agreement that you believe is more favorable. A lender will pay off your existing debt, and then issue you a new loan that you will then have to repay.
Many individuals look to refinance because they are seeking lower interest rates and/or seeking lower monthly payments. If current interest rates are significantly lower than the interest rate in your debt agreement, then you may want to explore your options when it comes to refinancing. Having a lower interest rate will result in you paying less in interest if you shorten your repayment period or keep the same length of your agreement. Note that if you refinance for a lower interest rate but lengthen your repayment period, you will pay more in interest (for example, say you had 20 years remaining to pay off your mortgage debt, and you refinanced and agreed to repay the balance over 25 years, you will repay more in interest, than if you had kept your original loan, since now you have added back 5 extra years to your loan term).
In other instances, people may be looking to lower their monthly payments. For many reasons, things can happen which makes it difficult for an individual to keep pace with their monthly payments (for example, the loss of one’s job). For this, some people seek to refinance, so that they can lower their monthly payments, and “free up” some of their funds to handle other financial priorities. Most times, lower payments mean spreading the debt over a longer period. As mentioned above, lengthening the loan period will result in an individual paying more in interest. However, for some people, this is one of their options, to avoid defaulting on their loan.
Refinancing may sound like an easy fix to get out of a burdensome debt agreement to one that is more manageable, but other factors such as cost, eligibility, and potential benefit should be considered. To refinance is not cheap. There are costs involved which could include: application fees, penalty fees, closings costs, attorney fees, among others. These costs quickly add up, and could outweigh the potential benefit. Some lenders do offer the option to roll these added costs into the balance of the loan, which will become part of your monthly payment. Again, this is added debt that you will have to repay, so you must look at your options to see if it makes sense for you to refinance. When it comes to eligibility, credit standing plays a big part. If the your credit scores are low, then you may not be eligible to refinance and get a new loan. If your credit score has improved since the issuance of the old debt, then you may be eligible to refinance. It should also be noted that some debt agreements may state a minimum hold period before the holder can refinance the debt. For example, some may require that the borrower holds the debt for at least 12 months before that can look to refinance.
While the overwhelming majority of people who refinance do so to lower payments, there are many people who refinance to increase their monthly payments. The ones who choose to do this, do so to shorten the loan term. For example, if an individual had 15 years remaining on their loan, and wanted to pay off the loan in 10 years, instead of 15 years, then their monthly payment would increase. Some chose this option because they want to pay less interest over the life of the loan.
The decision to refinance is an individual one, and may or may not always be the best decision for you. There are many factors to consider, and the decision should only be taken if it results in you saving money in the long term and the new agreement results in you being in a more favorable financial standing than if you had not refinanced.