In some ways, refinancing your current loan for a new loan can feel like trading apples for slightly different apples. You still have a monthly payment and long-term financial responsibilities, but refinancing has the potential to deliver significant benefits depending on your situation. A refinanced loan can yield lower interest rates, fund a future endeavor, help with debt consolidation or shave off some years on your financial commitment. It can also cost you a sizable investment to put into place, so it is a decision that should only be made after doing the proper diligence.
Upsides of refinancing
The strongest reason for refinancing a loan is the chance to save money, according to The Balance writer Justin Pritchard. In addition to upfront interest rates that are lower than your current loan, Pritchard reports that refinancing a loan can mean spending less on interest as a result of a shorter commitment. You might have higher monthly payments as a result, but you’ll be able shave considerable time, perhaps even years, off of the lifespan of your loan.
According to Investopedia, refinancing to a shorter-term loan may only cost you a little more up front. In an example, Investopedia writes, “For that 30-year fixed-rate mortgage on a $100,000 home, refinancing from 9.0 percent to 5.5 percent can let you cut the term in half to 15 years, with only a slight change in the monthly payment from $804.62 to $817.08.”
If you currently have an adjustable-rate loan, refinancing gives you a chance to change to a loan with a fixed rate. According to Investopedia, a fixed-rate loan means predictable monthly payments, no stress over spikes in interest and can result in a lower interest rate.
If you’re carrying a substantial amount of credit card debt, refinancing can seem like a way out of a deep hole. Pritchard cautions that consolidating high-interest-rate debt by refinancing is a precarious move; if you were to pay off your credit card using a home equity loan, defaulting could result in putting your home at risk and undoing your very way of life.
Refinancing allows you to opt for an adjustable-rate loan if you’re unsatisfied with the terms of your fixed-rate loan or are looking to capitalize on lower interest rates. A loan with adjustable rates can mean lower payments when interest rates are down, but when interest rates rise, you’ll have to pay. This spike in monthly payments can knock your initial savings and planned savings out of your account. Pritchard cautions that your monthly payment might even become impossible to fulfill with an adjustable-rate loan, and thus you should only consider doing so if you are positive that you would be able to manage higher monthly payments.
Possible refinancing scenarios
Refinancing doesn’t have to be all about saving money. In some cases, you can refinance a loan to fund your future business, home-improvement projects or ongoing education. Pritchard agrees that these are better reasons to refinance than just spending money to accumulate material goods or to fund vacations, but if not handled responsibly, refinancing can put your entire financial present and future at risk.
With significant benefits and drawbacks, refinancing a loan can be a saving grace or a money pit. Before you become blinded by the benefits of refinancing, make sure the process won’t be more of a hassle than what it’s worth. Speak with a trusted financial advisor and determine what works best for your needs.