When does it make sense to refinance your loans?
It’s more simple than you might think, if it’s going to save you money at the end of the day you should certainly take the opportunity to refinance.
- Achieving a lower interest rate
- Interest rates fluctuate and can depend on several factors such as the time frame and the lender. Refinancing can lower your interest rate on the money you owe.
- Changing the loan time frame
- You may need more time to pay off your loan and if your increasing your time frame, this can allow you to achieve a lower interest rate.
- Combining loans together
- Also known as consolidating loans, it combines all your payments into one monthly payment rather than several, spread out payments for multiple loans. This allows for simpler debt management to the average person.
- High transaction costs
- Bigger loans, such as home loans, can be expensive to refinance due to transaction costs.However some loans can contain costs that could be but are not limited to, closing costs, processing fees, reorganizing fees.
- Paying more in the long run by mistake
- Here’s a very broad example to explain. Let’s say your paying 10% per month on a $12,000 loan over a one year period. At the end of the year you will pay a total of interest of about $660 on top of the $12,000 loan, $12,660 in total. However if you refinance that loan to only 7% but over a two year period, your total interest paid will be about $895 therefor making your total amount due $12,895. In this case refinancing actually forces you to pay more in interest even though you are getting a lower yearly interest rate.
All in all refinancing loans requires careful consideration and calculation before proceeding. It is absolutely essential that if you do refinance you at least break even at the end of the loan period. For calculations you can use an online loan calculator such as the one on the Bankrate Website.