Usually when we take out loans, at the time of signing the loan documents we are often happy with the interest rates and terms of the loan, which is why we proceed to close the deal. But down the line, meeting the obligation of making the monthly payments for the loan becomes challenging for some borrowers, and some end up defaulting on their payments. 

This is often caused by several factors including a change in financial status, loss of job, or new financial commitments that have suddenly made making monthly payments a burden. In some cases, the borrower could default for months. This situation can be frustrating to handle, and that is why consumers have the option to refinance their loans whenever they feel the current terms are no longer favorable to them. 

Refinancing is a financial process that involves settling an old debt or loan with a new one that has more favorable terms and rates. Basically, you take out a new loan that has a term or rate that suits your current financial capabilities. This new loan is then used to pay off the existing one, leaving you with the new which according to your financial situation, wouldn’t be difficult to pay back. While this option may be open to any consumer, the possibility of your application being successful depends on several factors including your credit score, the current market interest rates, if you’ve taken out a mortgage, how much equity you have in the home, and so on. 

A Closer Look at How Refinancing Works

Consumers refinance their loans because of two main factors. One, there’s been a change in economic conditions that has led to a drop in interest rates, or two, they want an offer that suits their pocket at that time. The latter could be that their finances are better off now, and they’d like to settle the debt as quickly as possible, or that their financial status has worsened, and they’d like to get a better rate and term that’ll save them from defaulting. 

The basis of refinancing is to get a new loan that settles the existing one, but that can be paid off comfortably in your current financial situation. However, when examining the bigger picture, the consumer sometimes ends up paying more in interest over time. For example, if as a borrower, you’ve been making monthly payments of $1500 since you took at a loan 10 years ago, but for whatever reason, paying this amount every month has become challenging, you could refinance the loan. 

Depending on the outcome of the lender’s re-evaluation of your situation, you could end up either having your loan term extended, which will lead to a reduction in your monthly payments, or you may qualify for a new rate that is better than the former one and have a reduction in your monthly payment. With the first scenario, borrowers almost always end up paying more in interest over the duration of the loan. All things considered, the consumer’s goal of getting an offer that suits their present situation is met. Moreover, once your finances get better, you can always refinance the current debt into a better one. 

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Common Consumer Loans that can be Refinanced

Common consumer loans that can be refinanced include:

  • Mortgages
  • Auto loans
  • Student loans
  • Credit cards

Mortgages

Homeowners refinance their mortgages for two main reasons, which are, one, to shorten the length of their term usually from a 30-year plan to a 15-year plan, or two, to lower their monthly payment. For example, a consumer who financed the purchase of their home with an FHA mortgage pays more mortgage insurance than a consumer with conventional mortgages, who stops paying insurance after reaching 20% equity in the home.

Borrowers with an FHA mortgage that have hit the 20% equity mark could refinance into a conventional mortgage to stop mortgage insurance payment. An FHA mortgage is backed by the government and allows borrowers to make low, down payments. Click here to learn more about it. 

Similarly, many consumers have refinanced from a 30-year mortgage into a 15-year mortgage to pay off their debt quicker. They do this when their finances are better off, and they can afford to make bigger monthly payments. This is because upon shortening the term, monthly payments are increased. Overall, because the debt is paid off quicker, money is saved from the interest that would have accrued over the 30-year period. 

Borrowers who are considering refinancing their mortgage should note that there’s a possibility that it may not be a financially prudent move, especially if you’re refinancing to lower monthly payments by $100 or $200. This may not be worth all the trouble because the closing costs of a new loan can be quite high. So, make sure all these factors are carefully considered before making a decision. 

Auto Loans

Refinancing is done by car owners mostly to lower their monthly payments. When you sense that you’d likely default on your payment, refinancing can help sort things out and keep your finances stable. However, you should bear in mind that banks and some lenders may have certain eligibility requirements that your car must meet to qualify. These requirements often include mile caps, outstanding balance, and the age of the car. That said, do not let any of these discourage you. Approach your lender to discuss your situation and they may be able to work something out for you. 

Credit Cards

Interest on outstanding credit card debt accrues rapidly and is usually higher than personal loans. Therefore, many borrowers use personal loans to pay off credit card debts. By refinancing, they pay off their credit card debt, having a debt with less interest rate that can be paid off rather comfortably. 

Student Loans

Students will refinance loans or refinansiere lån, as it is said in Norwegian, to consolidate multiple loans into one payment plan. Usually, students can take out multiple loans from different lenders to finance college. These loans could be federal and private loans, multiple federal loans, or multiple private loans, with each possibly having different interest rates. 

What this means is that the student may be making multiple monthly payments which can be quite challenging and stressful. But by refinancing with one lender, all those other debts are paid off, and the student only has to make monthly payments to one company, making debt management much easier. Also, there’s the possibility of getting a lower interest rate.

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When is the Best Time to Refinance Debt?

There’s no one-size-fits-all answer to this question as borrowers’ situations can vary significantly. That said, these three events should cover most consumers’ situations. One, when you notice that your current financial situation has gotten worse than when you first took out the loan. This could have been caused by several factors that have already been mentioned earlier (please refer to paragraph 2). 

Secondly, there may have been a change in the economic condition, possibly a new monetary policy that has caused market interest rates to drop. This is also a good time to pay a visit to your lender to see if you could lower your rate. Finally, if your finances have improved, say you’ve gotten a better job, a salary raise, or you’ve won the lottery, and can now afford to make higher monthly payments, you should refinance to pay off your debt quicker and save money on interest. 

Final Thoughts

If you’re considering refinancing, it may be worthwhile for you to know some of the steps involved beforehand. This gives you an idea of what to expect during the whole process. 

Some of the steps involved in refinancing include:

1. Applying: Of course, you need to make your intentions known to your lender by applying. It is worth mentioning that you can choose to refinance with a different lender, and not necessarily the current one. 

2. Underwriting: In this stage, the lender verifies all the financial information and documents you’ve presented to him for the evaluation of your financial status. 

3. Deciding whether to lock your interest rate.

4. Closing the deal: You sign all the necessary documents to seal the deal at this stage.