In fact, I’d encourage you to go grab a pen and paper right now. Write down every debt you have, including its interest rate. With this list in hand, read the rest of this article to learn how you can save money by refinancing some–or even all–of these debts! Here’s how.
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, ideally 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.
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The goal of refinancing your mortgage is usually to save money over the life of the loan, either by paying it off more quickly or by lowering your interest rate. Sometimes, though, you might refinance for different reasons. For instance, you may need to refinance a student loan to remove your parents as cosigners on the loan. But even if you have a different end goal in mind for refinancing, you should always try to save as much money as possible during the process.
As an aside, a loan consolidation is a bit different. With consolidation, you turning multiple loans into a single loan. This process is a form of refinancing, but involves trading multiple debts for one. Sometimes consolidation can save money by lowering your interest rates, but it may actually cost you more money by lengthening your repayment period. It all depends on the terms of the loan.
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 or to remove a cosigner from your loan.
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, 15-year mortgage rates tend to be much lower than rates on 30-year mortgages. With the lower rate and shorter term combined, you may save tens of thousands of dollars on interest over the life of your loan, and you’ll pay down the principal much more quickly.
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. You can use a cash-out refinance to borrow money for your child’s education or to renovate your home, for example. When mortgage interest rates are particularly low, a cash-out refinance can be a much cheaper loan option than a personal loan or traditional student loan.
(Just remember that when you do a cash-out refinance to tap into your home’s equity, your home is acting as collateral for these expenses! Make doubly sure you can handle the terms of the new mortgage before you take this step.)
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.
What if you’re dealing with loads of credit card debt? In this case, refinancing to a lower interest rate can help you knock out the principal much more quickly, and could save you hundreds or thousands of dollars.
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.
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Refinancing often costs cash up front. For instance, refinancing a mortgage often involves closing costs similar to when you originally purchase a home. Refinancing a car may have similar up-front costs, and using a balance transfer credit card to refinance your credit card debt may involve a balance transfer fee. Even refinancing personal and student loans can cost you in the form of finance charges.
Larger debts are likely to cost more up-front to refinance, while refinancing smaller debts may not be as expensive. Still, always make sure you understand the terms of the refinance loan or credit card balance transfer. Plus, you need to definitely make sure that you’re not spending more money than you’ll save.
How to Refinance All Your Debts
As I said earlier, you can refinance any debt with the proper steps. Let’s look at some of the ways that you can refinance various types of debt.
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, a government program that can help you get better mortgage terms even if you’re underwater on your home or don’t have much equity.
To qualify for the HARP program, you need to have a good recent repayment history, own your home as your primary residence, and have a loan owned by Freddie May or Fannie Mac. Your loan much have originated on or before May 31, 2009, and you need to have a current loan-to-value ratio of at least 80%.
Another option if you don’t qualify for this program is to take out two loans — one for the part of your loan that’s over your home’s current value, and another for the rest of your home loan.
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. It used to be that these unsecured loans were very difficult to refinance, but more lenders are jumping into this space. Currently, several lenders exist almost solely to refinance student loans, including SoFi. Traditional banks, like Citizens Bank, are also getting into student loan refinancing.
Here’s the thing, though: since student loans are unsecured and are often quite large, you’ll probably need great credit and a solid source of income to qualify for this type of refinancing. If you’re not quite there yet, take some time to work on your credit score before you apply for student loan refinancing. Even if it takes a couple of years to get there, refinancing could save you thousands over the life of your loan.
Can’t find a lender who will let you refinance your student loans or other unsecured loans for a lower rate? Consider one of these options, instead:
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 mortgage 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. Because HELOCs are revolving loans, they often have an adjustable interest rate (though some lenders allow you to convert to a fixed rate). Unfortunately, that rate is often higher than the rate for a home equity loan.
- 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. The advantage of a cash-out refinance is that the whole mortgage will benefit from a lower rate, especially if you take advantage of today’s still-low rates on fixed-rate mortgages.
On That Topic: How Will the Fed’s Rate Hike Affect Your Loans?
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 than you’re likely to pay on any credit cards. It’s also likely to be a lot lower than the interest 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.
Again, though, you need to be careful with this option. If you can’t pay on other unsecured debts, lenders typically can’t come after any of your assets to pay off the debt. But if you become unable to pay on your mortgage, lenders could foreclose on your home. This is always the biggest risk of converting unsecured debt into secured debt through refinancing.
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 one 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.
Are They Worth It? Credit Cards With Annual Fees
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. Also, be sure to read the card’s terms in full. If the interest rate will skyrocket to 15%, 20%, or more before you can pay off the balance of the loan, a balance transfer may cost you more than it saves. Take a realistic look at your payment plan, and run the numbers to make sure a balance transfer will save you money.
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 a lump sum to pay off part or all of your other debts, consolidating them into one loan with a single monthly payment.
The advantage of debt consolidation is that it often 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 easy 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. And, of course, making just one payment instead of five or six or more is much more convenient.
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. On top of that, they’re relatively quick to get. However, 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 balances, 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.