A Guide to Refinancing a Loan
Managing a loan, be it mortgage, auto, school, or personal, can often be stressful. There are various terms that you’re locked into for the life of the loan, meaning you have to meet those requirements without fail until your debt has been paid in full, regardless of how strict they are. Fortunately, there is one option available to borrowers—refinancing.
What is refinancing?
Refinancing involves replacing your existing loan with a new one that pays off the debt and creates a different contract between you and your lender. People typically opt to refinance when they want to get better terms, such as a lower interest rate, to help lower their monthly payment.
There are a few types of refinancing, each of which has positives and negatives depending on your specific situation.
- Rate-and-term: The most common type of refinancing, this type involves taking out a new loan with different terms and, in general, a lower interest rate.
- Cash-out: Borrowers tap into the equity they’ve built over time, taking out a portion of it and adding it to the total amount of the new loan.
- Cash-in: The opposite of a cash-out refinance, borrowers make a large cash payment to decrease their total loan, replacing the old loan with a new, lower one.
Why refinance?
Refinancing can be a good idea if interest rates suddenly drop by a significant amount. Let’s say you took out an auto loan or mortgage when rates were at 6 percent. If they drop to 3 percent several years down the road, refinancing could be worth considering. In this scenario, you may be able to refinance to lower your monthly payment; not only would you likely secure a significantly lower interest rate, but the loan size would also be smaller because you would have paid down the loan since you originally took it out.
You can essentially refinance any loan, but there are a few important considerations to keep in mind:
- The term of the loan could increase or reset to its original length, meaning you’ll pay more in interest over the life of the loan.
- There are refinancing fees of varying amounts dependent upon the size of the loan.
- If the loan term shortens, your monthly rate could increase since you’re paying it off over a shorter period of time.
How to refinance
As with all other loans, you’ll need to have a good credit score to secure a loan with good terms. If your score is lower than you would like, work to decrease your total debt and make sure you’re paying all your bills on time. Once you’ve built it back up, shop around for lenders, and get quotes from a few different options. Look for the best terms available, but make sure to check that they’re better than what you currently have. You can also approach your existing lender, who might be willing to give you better terms to keep your loan in-house. After you’ve picked a lender, verify all the terms and conditions before signing anything so you can have a clear idea of what you’re going to be paying and for how long.
The bottom line
If interest rates suddenly drop or your financial situation changes, refinancing could be worth considering. However, you’ll want to be diligent to ensure that the savings from refinancing outweigh the costs that come with the process. If you’re not sure if it’s the right move for you, reach out to a financial advisor or your mortgage lender to discuss your options.
This article was prepared by ReminderMedia.
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