If you aren’t happy with your mortgage, auto loan or student loans, there’s no reason to feel trapped by your current lender. Refinancing allows borrowers to take out a new loan and pay off the old one. The result can be a lower interest rate, more favorable terms or even the opportunity to walk away with cash in your pocket.
However, if done at the wrong time, refinancing could end up being a costly mistake. To avoid a financial misstep, stick to the following seven guidelines about when experts say it makes sense to refinance.
[Read: A Guide to Refinancing or Consolidating Your Student Loans.]
1. When interest rates are on the move. Interest rates are rising, so you might want to think about refinancing variable interest rate loans. “Locking in a fixed rate is always a good idea,” says Brendan Coughlin, president of consumer lending for Citizens Bank.
Alternatively, if your mortgage is 20 years old, you could be paying a significantly higher interest rate than what is being offered today. While you want to take advantage of low rates before they rise, it’s wise to consider whether refinancing will save you money.
2. When your credit improves. Even if interest rates aren’t falling for everyone, they could be for you if your financial situation has improved. “Our view is that the day you graduate and get a job is the day you should refinance your [student] loans,” Coughlin says.
Steady income and a history of paying bills on time can lead to lower rates for various types of debts. Stephen Dash, founder and CEO of Credible, a platform that connects student loan borrowers with lenders, says people need to be careful they don’t give up any benefits when refinancing. He notes private student loan lenders may not have income-driven repayment plans or participate in public service forgiveness programs.
3. When you want to lower your payment. Families on tight budgets may find refinancing provides relief from high payments. In many cases, this is achieved by extending the term of the loan. Borrowers need to carefully weigh whether the monthly savings are worth paying on a debt for years longer than originally planned. “Generally, it is not desirable to extend the loan term if you’re increasing the length of the loan by more than a few years,” says Kevin Gahagan, principal and chief investment officer for Mosaic Financial Partners in San Francisco. Doing so could mean paying thousands more in interest over the life of a loan.
[Read: How to Cope With Student Loan Debt in Retirement.]
4. When you want to get out of debt earlier. Just as you can refinance to extend the life of a loan, borrowers can also refinance to shorten the term. While technically not refinancing, Coughlin says consolidating credit card debt into a single personal loan is one way to shorten a repayment period. “You know you’re going to pay that $10,000 over three years instead of only paying interest [indefinitely],” he says.
5. When you need cash. Cash-strapped households may find they are able to tap into their equity when refinancing a mortgage. Some banks may also consolidate credit card debt into a personal loan and include an additional payout to the borrower. While adding debt isn’t something to be entered into lightly, refinancing for this reason may be helpful to those who have exhausted other options.
6. When you want to simplify your finances. Dash says many people choose to refinance their student loans to simplify their life. “On average, a borrower graduates with eight different student loans,” he says of his experience in the industry. By refinancing several loans into one new product, people can streamline the debt-repayment process. It may also help minimize the chance of missed payments and late fees.
7. When it won’t cost you much. Refinancing can save money, but it isn’t free. There may be bank fees and other costs, particularly in the case of a refinanced mortgage. “Ideally, if closing costs are involved, you want to be able to recover [those] within 12 to 18 months of loan origination,” Gahagan says.
[Read: A Complete Guide to Refinancing Your Home Mortgage.]
Keeping costs down means looking over the fine print and checking the rates at several institutions to ensure they justify the cost of refinancing. Many financial institutions provide instant quotes on their websites. Other sites act as intermediaries to provide rates from several lenders.
For borrowers, refinancing can save money, reduce monthly payments and provide a source of cash. However, take care to avoid paying too much for a loan that comes with too few benefits.
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7 Times It Makes Sense to Refinance a Loan originally appeared on usnews.com
