Loan Refinancing Explained

At Freedom Debt Relief, the more we can share about financial solutions, the better off the average consumer will be. 

For example, we're often asked about loan refinancing and if it can really benefit a person facing a small mountain of debt. Stick with us as we dive into refinancing to help you determine whether it's something that might help you find your way out of debt at a quicker pace or if another option would be a better fit for your situation. 

What Is Refinancing? 

When you take out a loan, you agree to repay the amount you borrow, plus interest and fees, over a specified period. When you refinance a loan, you take out an entirely new loan to pay off a previous loan. Typically, the new loan has better terms that could help you save money, pay off the loan sooner, or both. This is the reason why refinancing is such a popular option among borrowers.

Whether you have a home loan, student loan, or other debts, refinancing could help you optimize your debts. But refinancing isn’t always a good idea. 

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More About Refinancing

Here's how we answer some of the frequently asked questions about debt refinancing.

What kinds of debt can I refinance? 

You can refinance almost any type of loan, including car loans, home loans, student loans, personal loans, and even credit card debt. While refinancing could change the terms of your loan, one thing stays the same: You still owe the debt, and that debt won't go away until you pay off your new loan.

Can I borrow extra while I'm refinancing? 

In some cases, you can refinance your loan and borrow extra money at the same time. Refinancing a mortgage is a great example. 

A cash-out mortgage refinance is a new mortgage that’s bigger than your old mortgage. You use the new loan to pay off the old mortgage, and you get the difference in cash that you could spend. This means you’ll have extra funds to consolidate debt, make home improvements or repairs, or reach another financial goal.

Are there any risks associated with cash-out refinancing?

A cash-out refinance is a secured debt. It’s guaranteed by the home. If you fail to repay the loan, the lender sells the home to recover its losses. 

The risk of secured loans is that you could lose the asset if you don’t repay the loan. Why does anyone want a secured loan? Secured loans are typically the cheapest way to borrow. That asset is a financial safety net for the lender. In other words, there's less risk to the lender of losing money. 

For unsecured debts like personal loans and credit cards, there is no financial safety net for the lender. 

Before you decide whether refinancing is right for you, consider both the pros and cons. 

Pros of Refinancing

It takes time and money to refinance, but several big benefits could make the process worthwhile.

Save money on interest

The most significant benefit of refinancing is that you could save money. If you refinance at a lower rate but you keep making the same payments, you’ll pay off the loan sooner and pay less interest overall. 

Reduce your monthly payment

Another reason to refinance is to lower your monthly payment. A refinance loan could get you a lower monthly payment now if you get a lower rate or take a longer repayment term (or both). 

Pay off your loan faster

You may be able to secure a lower interest rate and, at the same time, shorten the length of your loan. While your monthly payments may be larger, you could pay off the loan sooner and clear the debt faster.

Consolidate debt

If you want to simplify your debt payments, refinancing could be a smart way to reduce the number of bills you pay. Debt consolidation means taking a new loan and using it to pay off multiple smaller debts. It could make sense if the new loan gets you a lower interest rate compared to what you currently pay.

Cons of Refinancing

While refinancing has its benefits, it isn’t always the right solution. You’ll need to weigh your options carefully because refinancing has some notable drawbacks, too.

Transaction costs

Refinancing can be expensive, and in some cases, the refinancing costs could even outweigh the benefits. There could be closing costs, origination fees, and other processing fees. Do the math beforehand, including all fees, to decide if refinancing makes financial sense.

Higher interest costs

If you refinance and take longer to pay back the debt, you could end up paying more in interest over time. When you spread out your payments over a longer period (even at a lower interest rate), the monthly payments could be lower, but the interest could add up to even more over the life of the loan.

Longer time in debt

Some lenders will offer to decrease your payments by extending the length of your loan, but a longer term means longer in debt. Ideally, refinancing should make your debt more efficient and manageable, not more expensive or more of a burden.

Refinancing has many pros and cons, and whether you should refinance depends on your current situation and how much you’re currently paying for your loan.

When to Refinance

In general, if you can save money on your existing loan, refinancing could make financial sense. Here are two situations when refinancing might be the best option.

When rates are low

If interest rates fall, you might save money if you can lower the interest rate on your existing debt. But how much should rates drop before you refinance? Some experts say to refinance if rates are two percent or more below your current rate. 

However, each borrower’s situation and financial goals are different. You’ll need to consider all your associated costs and determine if a new loan will genuinely save you money.

When your credit has improved

Your credit score plays a huge role in determining your interest rate. Generally speaking, the higher your credit score is, the lower the interest rate you’ll receive. If you’re keeping up with payments on your current loan and your credit score has improved, you might qualify for a better rate and more favorable terms.

Refinancing could be a smart choice if you can save money by doing so or if your circumstances have changed and better rates are available. 

How to Refinance

Here are the steps you’ll take to get started with a loan refinance. 

1. Review your loan options

Start by shopping around and collecting quotes from local and online lenders. Comparing rates and terms from multiple lenders will help you find the best possible interest rate, lower fees, and help you make a more informed decision on your refinance. It’s a great idea to start by talking with lenders who can check your rate with a soft credit inquiry that doesn’t hurt your score.

2. Make sure the new loan aligns with your financial goals

After comparison shopping, you may discover that one loan makes more sense than another based on your circumstances. The new loan should be one that you can afford to pay each month, helps you save money now or over time, and allows you to reach your goals.

3. Lock in your rate

Once you’ve identified a new loan, run the numbers and figure out how much you stand to save. Refinancing may be the right choice for you if the savings on the new loan are greater than the upfront investment (in loan fees). Move forward with the lender by locking in your new rate and starting the refinancing process.

The Bottom Line on Refinancing

In many cases, refinancing aims to get a lower interest rate and save money over the life of the loan. It could also help relieve some of your financial stress by lowering your monthly payments and giving you more time to repay the loan. 

Everyone’s situation is unique. Review your goals and make sure the loan you're considering will actually help you achieve them. Then, look for the right lender, one with rates and terms that fit your needs.