What do you think of when you hear the word refinance? If you’re like most people, you probably think of
refinancing a mortgage.
In my weekly newsletter, however, we’ve been talking about how you
can refinance any debt. I’ve encouraged my newsletter subscribers to
write down every debt they have, including the interest rate. With the
list in hand, they are reviewing each loan to determine if they can
lower their interest rate. It’s one of the
easiest ways to save money.
So today I thought we’d look at what refinancing involves, why you
might want to refinance, and how to refinance any type of debt.
What is Refinancing?
Refinancing is trading one debt for another. If you refinance your
mortgage, you’re trading your original mortgage for a new mortgage,
usually with better terms that save you money.
You could also trade your credit card debt for a lower-interest home
equity loan, which is refinancing. Or you could move your car loan to a
new lender to get a better interest rate.
Sometimes you refinance with the same lender. In this case, you’re
changing the terms of your original loan based on new financial factors,
such as a better credit score on your part or lower overall mortgage
interest rates. Sometimes, you may take out a new loan to pay off the
old loan, getting better loan terms in the process.
As an aside, a loan consolidation is a bit different. With
consolidation, you are usually consolidating multiple loans into a
single loan. This process is a form of refinancing, but involves
trading multiple debts for one.
When Should You Consider Refinancing?
Usually the goal of refinancing is to save money, especially on
interest paid over time and on monthly payments. But you could also
choose to refinance to change your loan terms.
For instance, you might
refinance your mortgage from a 15- to a 30-year loan.
A longer term gives you lower (often much lower) monthly payments,
which are great if you’re in a financial pinch. Even if you’re paying
your 15-year mortgage with ease, you might want to take a longer term
and invest the extra money each month, hoping to come out ahead
financially in the long run.
On the flip side, you might choose to
refinance your 30-year mortgage to a 15-year mortgage.
If you want to be debt free faster, this is a way to make it happen
without making extra mortgage payments. Plus, the shorter loan term can
save you tens of thousands of dollars in interest paid over time because
15-year interest rates are lower and you’ll pay down principal faster.
If you owe less on your home than it’s worth, you might want to
do a cash out refinance, in which you remortgage it and take the difference in cash.
One more option is to switch from a variable-rate mortgage to a
fixed-rate mortgage. A set interest rate and predictable payments can
make it much easier to plan your personal finances.
As you can see, there are many instances in which you might consider
refinancing your debts. Be sure you run the proper calculations,
especially if you’re refinancing a larger debt like a home or a car.
These refinances can cost you cash up front, so make sure they’ll be
worth your while in the long run.
Refinancing other debts, on the other hand, may not be so
complicated. If you’re dealing with high-interest credit card debt, all
you need to do is
transfer the balance to a lower-interest card to save a fortune.
How to Refinance all Your Debts
As I said earlier, you can refinance any debt with the proper steps.
Here are some of the ways that you can refinance various types of debt:
Straight-up refinancing
Although any of these methods is refinancing, let’s first talk about
traditional refinancing. This term is most likely to be used for
mortgage loans, auto loans and student loans. Basically, you either get a
loan with better terms from your current lender or from a new lender.
The key to this is to shop around for your new loan.
Refinancing your mortgage may take more legwork because you’ll likely
need to talk with loan officers about refinancing offers and the
potential costs of the process. When refinancing a secured loan like
your home or auto loan, you may not be able to refinance if you owe more
than the home or vehicle is worth. A loan for more than an item is
worth is riskier for lenders.
We talk elsewhere about
how to refinance a home in which you don’t have a lot of equity. One option is to refinance through the
Home Affordable Refinance Program,
and another is to take out two loans, one for the negative equity in
your home, and another for a regular mortgage at a lower rate.
If you have negative equity in your vehicle, you may need to take out
a separate, unsecured loan to pay down part of the car loan. For
instance, if you owe $15,000 on a car worth $11,000, take out an
unsecured loan (or use a low-interest credit card) to pay off $4,000,
and then refinance the remaining auto loan. Or you could keep paying on
the vehicle until you build more equity.
Finally, let’s talk about straight-up refinancing of student loans.
Because student loans are unsecured, it’s very hard to get a new lender
to take them on at a lower interest rate or better terms.
Bloomberg’s BusinessWeek notes
that there are several ways to change some of your student loan terms.
If you can’t make minimum payments on federal loans, look into modified
payment plans or forbearance. Even some private lenders offer
forbearance in some instances.
Unfortunately, you probably won’t be able to refinance these loans at
a lower interest rate simply by finding a new lender. But you may be
able to use one of these options for refinancing your student loans:
Using your home’s equity
If you have equity in your home, you can use that to refinance some
of your other debts, such as school loans, credit cards or other
personal debts. There are three options for doing this, including a home
equity loan, a home equity line of credit, and a cash out refinance:
- Home Equity Loan: This is an installment loan based on your
home’s equity. It’s also known as a second mortgage. If your home, for
instance, is worth $500,000 and you owe $300,000 on your first mortgage,
you could borrow $150,000 against your home’s value as a second
mortgage. You’d pay back this type of loan in set installments, just
like your first mortgage. All other things being equal, however, the
interest rate on a second will be higher than your first mortgage
- Home Equity Line of Credit: This is similar to a home equity
loan, except that it’s a revolving debt like a credit card. With a
HELOC, you can write a check or use a debit card attached to the
account, pay back some or all of the charge, and then charge again.
- Cash Out Refinance: Instead of taking out a second mortgage
as a home equity loan, you might consider a cash out refinance, which
will leave you with one mortgage payment. In the home equity loan
scenario above, you could just refinance your first mortgage as a
$450,000 mortgage, and take the excess $150,000 in cash.
Using your home’s equity to refinance other debts can be a good
option because a secured loan against your home’s equity will likely
have a much lower interest rate than the rates on other debts.
The rates you’ll pay on a home equity loan are typically much lower
rate than you’re likely to be paying on any credit cards, and it’s also a
lot lower than the locked-in 6.8 percent rate on federal student loans.
So you could lower your overall debt payments and reduce the time it
takes to pay off debts by using your home’s equity to pay off the
balance of other loans.
If you can’t pay on your credit cards or student loans normally, the
creditors can’t come after your property directly. If you can’t pay your
HELOC or home equity loan, your lender could foreclose on your home.
Refinancing with credit cards
The most common way to refinance credit card debt is a balance
transfer. You transfer the balance from one credit card to another,
normally with a much lower interest rate.
Your best bet is to consider a zero interest credit card set up to
encourage balance transfers. Note that some balance transfer credit
cards come with fees, even if they have a limited-time zero interest
rate on balance transfers.
There are some
no-fee balance transfer cards
available, so you should check out these options first. Some cards have
an option for either zero interest with a balance-transfer fee (which
is usually a percentage of the balance you transfer), or a zero transfer
fee with a low interest rate. You’ll have to
do the math to figure out which works best for you.
If you get a really great deal on a credit card and have enough
available credit, you can use a credit card to refinance other
higher-interest debts, as well. For instance, you could pay off a very
high-interest personal loan with a lower-interest credit card,
effectively using your credit card to refinance it.
Always check your credit card contract first because different types
of purchases, transfers and payments may result in different interest
rates.
Debt consolidation
If you’re swamped in debt and are unable to make minimum payments on everything,
debt consolidation could be a good option. You’ll get one large loan to pay off part or all of your other debts, consolidating them into one loan.
The advantage of debt consolidation is often that it lowers your
overall monthly payments, a relief for hard-hit consumers. Depending on
the interest rates of the loans you’re carrying, consolidation may lower
your overall interest rate and total interest payments.
According to the FTC,
using your home’s equity is the most common way to consolidate debt,
but you may also be able to get a consolidation loan. However, some
disreputable so-called debt relief organizations will offer
debt consolidation loans that aren’t a great deal.
They may increase the overall interest paid, extend your repayment time
to decades, or charge fees that increase your overall debt load.
It’s very common to consolidate student loan debt, and this is
usually an automatic option with federal student loans. If you took out
student loans for several years in a row, you probably have several
loans from several lenders. It’s a pain to make so many separate
payments, and your minimum payments are probably quite high.
In this case, you can consolidate all your loans into one by a single
lender. Consolidating federal loans usually means that you lock in your
interest rate, which may otherwise vary from year to year. Plus, you
could lower your overall monthly payments and gain access to several
repayment plans.
You’ll have to consolidate private student loans separately, but there are several lenders who will do it. You can
read more about how to consolidate student loans here.
Using LendingClub or Prosper
LendingClub and Prosper
are peer-to-peer lending marketplaces. Basically, you can get a fairly
low rate on an unsecured personal loan that comes from other individual
lenders.
LendingClub statistics say that nearly half their loans are used to consolidate debt or pay down credit cards with a lower interest loan.
Peer-to-peer lending options generally come with competitive interest
rates that depend on your credit history, and they’re relatively quick
to get. But the loan limits are usually around $25,000, though you may
be able to take out multiple loans at once. They can be a good option if
you need to refinance debt quickly.
The Bottom Line
Refinancing some or all of your debts may or may not be a good idea.
Look at your debts, interest rates and minimum payments. If you could
reduce interest rates significantly, refinancing is usually a great
option. Also, if you can lower your monthly payments, you could kick the
money you save into paying off your principal balances more quickly, or
into investment accounts that allow you to save for the future.
source: doughroller.net
