In a country up to the brim with consumer debt, Americans are looking for actionable strategies to climb out of the hole.
Hundreds of ways exist to get out of debt, but any involve behavioral and lifestyle changes. This leads debtors to refinance their loan, hoping new terms are enough to put them on the right path.
But is this always the best solution? Let’s discuss the pros and cons.
A Primer on Refinancing
Whether you’ve secured debt like a mortgage or unsecured debt like a personal loan, refinancing is always an option for debtors. The exact process may differ depending on the lender, but refinancing essentially replaces an existing loan with a new loan and terms. The debtor then uses the new loan to pay off their original balance. Pretty simple, right?
Let’s discuss why refinancing may and may not make sense depending on your situation.
Save Money in Interest
Many people look to refinance to get a better interest rate. Maybe interest rates were high when the loan was issued, or perhaps credit score has improved over the years. Whatever the situation, if more money can be applied to the principal each month via a reduced interest rate, it’s a sound financial strategy to employ.
Lower Your Payments
Life is expensive regardless of one’s frugality. Unexpected costs have to be expected at all times. When we’re short on monthly income, keeping pace with a balance and paying for the rest of life becomes challenging. Refinancing to lower monthly payments won’t save money in the long-term, but it can help keep your head above water during financial peril.
Consolidate Your Payments
It’s not just one balance that’s constricting so many Americans’ lifestyles. Per a Gallup survey, the average American has 2.6 credit cards, but this number increases to 3.7 when eliminating the amount of Americans without any credit cards (29 percent). Debt consolidation isn’t always an effective strategy depending on a debtor’s cash flow and commitment to repaying their balances. However, it simplifies monthly repayments, and in the case of credit cards, usually can offer a better overall interest rate than credit cards.
Switch Your Type of Interest Rate
Loans come in two types of interest: variable and fixed-rate. The state of the economy dictates which of these is better for a borrower, but in most cases, loans with fixed-rate interest are generally safer.
People with variable interest rate loans often refinance to fixed rate, but vice versa also makes sense if the debtor is factoring economic conditions and interest rate fluctuation over the loan’s lifecycle.
Shorten Length of Loan
It’s not a story of people crippled with debt, but not everyone borrows because they don’t have enough. If monthly payments on a loan don’t impact the budget too significantly, refinancing can help pay back the debt faster, and often at a lower interest rate to boot.
Transaction Fees
Most debt-assistance solutions come with fees. For example, debt settlement, according to Freedom Debt Relief, charges a percentage fee based on the overall amount settled. Refinancing, albeit a less severe strategy, often comes with transaction costs as well. Make sure to do the math on any type of refinancing option you’re considering. They don’t always make financial sense.
More Money Paid in Interest
Lengthening a loan so you can afford the monthly payments might get you through a rough patch, but it’ll also cost you more in interest. Again, calculate the actual cost of the refinance along with how it’ll aid your situation to decide if it’s truly a good idea.
Researching and Applying for Offers Is Time-Consuming
Even with the internet and litters of financial apps, applying for a new loan takes time and energy. It’s easy enough to get an overview of terms, but applying for loans and weighing your ultimate decision is a process. This is time well spent if better terms come out of it, but understand the commitment ahead of time.
Debt Can Spiral Further Out of Control
As mentioned above, refinancing can keep people from going under during hard times. But aside from desperate situations, taking out more debt to handle existing debt perpetuates an unhealthy, risky cycle. This is because refinancing, when done to lower interest rates or monthly payments, extends the length, and thus overall cost, of a loan. If we’re not equipped with a plan to handle the repayments, we’re heading down a treacherous path.
Refinancing a loan is a popular option because it offers a variety of benefits for certain financial situations. That doesn’t mean it’s foolproof, though. Keep the above considerations in mind as you decide if refinancing is right for you.
Thank you,
Glenda, Charlie and David Cates
