If you have debt that you are struggling to pay or is costing you too much money, refinancing could be an option for you. Interest can cause monthly payments to balloon out of control and finance charges like maintenance and late fees can sink you further into debt. Fortunately, credit card refinancing, loan consolidation and cash-out refinancing can help you save money and make debt more manageable.
What is Debt Refinancing?
When you refinance your debt, you replace an existing debt with a new one that has better terms. For example, you might replace an old loan balance with a new loan that has a lower interest rate. Or, you may transfer the balance on a credit card to a new card with an introductory APR that will save you money.
Debt refinancing also allows you to combine multiple debts into one. This type of refinancing is typically called debt consolidation.
Debt Refinancing vs. Debt Consolidation
Although they both help you manage your debt and oftentimes can help you save money, they do so under slightly different circumstances.
- Debt consolidation involves combining multiple debts into one consolidated debt.
- Debt refinancing helps you optimize an existing debt by replacing it with one that has better terms that will save you money.
Ways to Refinance Your Debt
There are many different ways to refinance your debt. Which one you choose usually depends on the type of debt you hold. The important thing to remember is that refinancing your debt doesn’t always require you to take on new debt that is the same as your old debt.
For example, if you have a personal loan, you can refinance the loan with a new loan or you could take a lump sum cash-out on your mortgage.
If you have credit card debt, you may decide to get a new card with better terms so that you can pay down the principal faster and save money on interest, or you take on a personal loan with better terms than your credit card.
Some of the most of the most common ways to refinance your debt include:
- Cash-out refinancing
- Credit card refinancing
- Refinancing a loan
A cash-out refinance allows you to borrow against your home loan with a new mortgage that is higher than your outstanding loan balance. In this method of refinancing you can refinance your current home loan with a loan amount that is higher that the remaining balance owed on your current mortgage. The difference between an old and new mortgage would be additional cash that you can use to make improvements to your home, make a large purchase or consolidate existing debt.
The amount of cash-out is usually based on the amount of equity you have in your home and its current value.
Mortgage lenders typically limit the amount that you can take in a cash-out. Though this can vary from bank to bank, it is usually around 80% of your home’s value. This allows you to maintain an equity cushion.
If you have equity in your home and have a good history of making your mortgage payments on time, you might consider cash-out refinancing as a way to settle other debts like credit cards, personal loans and car loans.
When is it a Good Idea?
- You have equity in your home
- Your home has increased in value
Cash-out Refinancing Example:
You originally purchased your home for $175,000 and have $100,000 in equity. Your home is currently valued at $235,000. So, you take out a new mortgage for $235,000, subtract the $75,000 you still owe on the old mortgage and get a cash-out lump sum payment of $160,000.
Your new mortgage has a shorter repayment term, and slightly lower interest rate than your old mortgage. You use $60,000 to pay off high-interest credit card debt, $50,000 to pay off your car loan and make home improvement and put the remaining $50,000 into an investment account.
Credit Card Refinancing
Credit card refinancing allows you to move the balance from one credit card to another, usually with a new creditor. This type of refinancing is often referred to as a balance transfer.
The new credit card should have a balance of equal or greater value than what you owe on the credit card you intend to pay off. This works best for consumers who have decent credit and are eligible for credit cards with good introductory interest rates.
Cards with a 0% introductory rate are good candidates for a balance transfer, especially if you can pay down the balance before the introductory period ends. Pay attention to the credit card terms. Some cards have balance transfer fees and introductory rates that may only apply to certain types of purchases or transfers.
When is it a Good Idea?
- You are eligible for a credit card with a much lower interest rate or 0% introductory period
- You can afford to pay more than the minimum payment on your new credit card
- You have the discipline require to pay down the credit card and will not be tempted to spend on your new credit line
Credit Card Refinancing Example:
You have $15,000 in credit card debt with a 4% minimum payment of $600/month and a 20% interest rate. At this rate, if you only paid the minimum balance it would take you 15 years to pay off the debt and would cost you over $10,000 in interest.
You are eligible for a new credit card with $20,000 limit and an introductory rate of 0% for the first 12 months. After the introductory period, the new credit card has an interest rate of 18%.
In the first 12 months you plan to make monthly payments of $750, just a little more than you were paying before. In the first 12 months you are able to pay down the principal by $9,000 leaving you with a balance of $6,000.
At the new rate, if you continued making $750 monthly payments, it would take you 39 months to pay off the card and would cost you just $581 in interest.
Refinancing a Loan
Refinancing a loan means taking out a new loan to pay off an existing one.
- You have an existing loan that you would like to improve in some way.
- You shop around for lenders and find one that offers better loan terms than your old loan.
- You apply for the new loan.
- If your loan is approved, the new loan pays off the existing debt completely.
- You make payments on the new loan until you pay it off or refinance it.
Pros and Cons of Refinancing
Pros of Refinancing
Lower Interest Rates: Getting a loan with lower interest rate, is one of the most common benefits of refinancing. You may be eligible for a lower interest rate if your credit score has improved or because of changes to the market conditions. Refinancing for a lower interest rate can save you a considerable amount of money in financing costs over the life of the loan.
Change Loan Terms: If you are unhappy with your current loan terms, refinancing can allow you make changes. For example, if you want a shorter repayment plan you could refinance a 30 year mortgage with a 15 year mortgage. Usually, shortening the length of the repayment will increase your monthly payment but can help you save considerably on interest over time. Alternatively, if you need a lower monthly that is more affordable for your short term budget, you could refinance for a longer repayment term, but you will probably pay more in interest over time.
Change Loan Type: Some loans have variable interest rates that cause interest and monthly payments to fluctuate from month to month.
Consolidate Multiple Debts: Refinancing can allow you to pay off multiple debts at the same time and consolidate your repayment into one, easier to manage loan and monthly payment.
Pay Off a Time Sensitive Loan: Some loans require you to pay down the balance by a certain date, or you will incur additional charges and penalties. You may decide to refinance this loan if you don’t have the funds available to pay down the balance on time. Refinancing can buy you time to repay the debt and help you avoid racking up lots of interest.
Pay Down a Past Due Balance: If you have a past due balance on a loan, refinancing can help you bring the loan current and prevent you from incurring late fees or other penalties.
Cons of Refinancing
Negative impact on credit score: Refinancing your debt requires a lender to make a hard inquiry on your credit which can lower your credit score.
Can cost more money over time if you go with a longer repayment plan: If you refinance your debt with the aim of lowering your monthly payment, you may end up with a loan that has a longer repayment plan. This may work to mitigate your short term financial needs, but could end up costing you more money over the life of the loan.
Can raise your minimum monthly repayment if you go with a shorter repayment plan: If your goal is pay the loan off faster and save on interest, you could be on the hook for a higher monthly payment. This can be con if it doesn’t work well with your current budget, so you’ll want to make sure you can afford the monthly payment before you agree to refinance.
Alternative to Debt Refinancing
If your debt is out of control, you may be past the point of debt refinancing. This may be the case if your minimum payments are too high, you are already behind on payments, have experienced a significant financial hardship or simply want to get out of debt faster and pay less in interest.
If this sounds familiar you should consider debt settlement programs as an alternative to traditional debt repayment and refinancing. Contact Accredited Debt Relief to speak to a Certified Debt Specialist. We can answer your questions and help you find a program that is right for you.