Is it time to refinance a loan or mortgage? This is a major life decision. Longer payment schedules might seem good right now, but they could end up burning you down the line. Paying too much, too soon, on the other hand, could rock your finances. How do you know? One way is to crunch the numbers ahead of time. Our Refinancing Calculator will give you a concrete idea of how you can balance factors like loan terms, timelines, and interest rates to create a smarter payment schedule for your financial situation.
What Is Loan Refinancing?
Refinancing involves taking out a new loan to settle an old one — usually a home mortgage. Often, the goal is to get terms more favorable to your current financial situation. For example, if your income increased and you can now afford to pay a higher mortgage, you can shorten the current loan by refinancing and increasing your monthly payment. On the other hand, if you’re struggling to make monthly payments, you can take advantage of lower interest rates or apply for a longer loan term to lower your payments and ease the burden.
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Advantages of Refinancing
The purpose of refinancing is to make your current loans adapt to your changing lifestyle and the shifting economic conditions. As such, the advantages of loan or mortgage refinancing will depend on your goals and the new terms you’ll get from the lender. Here are some examples:
- Lower interest rate: If you took out a mortgage at a time when interest rates were higher, refinancing will allow you to enjoy the current market’s lower interest rates moving forward. You may also be able to enjoy better rates if your credit score has improved significantly in the time since you took out the loan.
- Better interest terms: Interest rates fluctuate along with market conditions, so if you see that the market is getting worse, you can switch to a fixed-rate mortgage to lock in the current interest rates. That way, even if market rates go up, you’ll enjoy a fixed rate for the rest of the loan term. On the other hand, if the market is getting stronger, switching to an adjustable-rate mortgage makes sense so that if market rates go down in the future, so will your loan’s interests.
- Faster repayment: Being in debt is no fun at all; if you want to get out of your loan obligations quicker, refinancing will allow you to adjust your monthly payments and/or put down another down payment to be able to pay off your mortgage sooner than the original term. A shorter loan term also means lower interest total. Keep in mind, however, that shortening the loan term often means paying a higher monthly fee.
- Lower payment amount: As mentioned, lowering your monthly payments is another thing you can achieve with refinancing to help ease the financial burden of the loan. However, this will mean extending the loan term, which will result in a higher interest total to be paid.
- Consolidate loans: If you’re paying off multiple loans, you can also have a single lender refinance all of them so you’ll only have one loan with a single payment schedule. This makes sense especially if the lender offers lower interest rates compared to all of your current loans.
Disadvantages of Refinancing
As good as refinancing sounds, there are still disadvantages to it.
- You might not break even, or the savings may not be worth the effort: If you refinance, there will be added costs involved, like appraisal fees and closing fees. You can pay these out of your own pocket or add them to the total loan amount, but either way, you should calculate if the savings are worth the effort of going through the refinancing process. (See refinancing example below.)
- Your home equity could go down: If you take out a cash-out refinance and use your home equity to borrow, you’re effectively reducing the equity in your home. For example, if the cash-out loan amounts to $30,000 and your home equity is $100,000, you’ll only have $70,000 equity left. This could impact future financial moves, especially big ones.
- No immediate savings: While loan refinancing can help you save big in the long run, bear in mind that you won’t be saving money upfront. Savings from refinancing often come from savings in interests paid, which will slowly accrue as you reach the end of your loan term.
Example of Refinancing a Loan
To give you an idea on how refinancing works, let’s picture a scenario where John took out a mortgage to buy a $100,000 house with a 10% down payment, 5% interest, and a 30-year loan term.
- Principal loan amount: $90,000
- Monthly payments: ~$485
- Total interest after 30 years: $83,930
Two years in, he wants to refinance to a 15-year loan term.
- Remaining principal balance: $87,276
- Monthly payments: ~$690
- Total interest after 15 years: $36,955
In that case, refinancing saves John nearly $47,000 in total interest paid. Even if we factor in the closing costs and an appraisal fee (which, let’s say, is 7% of the $100,000 property price), he’d still save $40,000 total down the line.
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Should You Refinance?
Depending on the new loan terms you’ll apply for, refinancing has its pros and cons. It’s important to weigh those and what they mean to you financially before refinancing your loan. There are also added costs to refinancing, like closing fees and appraisal fees. Use our Refinance Calculator to calculate the bottom line of your refinancing and decide if it’s the right move.