Refinancing is the process of changing the terms of a loan or replacing one loan with another. It is often done to home mortgages or car loans.
However, other types of loans can also be refinanced, like student loans.
As a borrower, you may feel tempted to refinance to try to get better loan terms. However, it’s important to consider the pros and cons of doing so first.
Pro: Lowering Your Monthly Payment Amount
A lower monthly payment amount is one potential benefit of refinancing. That difference in payment size may be enough to help you stay on budget from month to month.
When your monthly payment amount is lower, it can potentially:
- Help you make loan payments on time.
- Save you money you can use for other immediate financial obligations.
- Reduce your general financial stress level.
Pro: Shortening Your Loan Term
You may opt to refinance to shorten your loan term. That is a process of reducing how long the loan lasts.
Paying your loan off sooner means you can own your vehicle or home outright faster. It also means you do not need to pay as much loan interest over time.
Pro: You Can Potentially Stabilize Your Monthly Payment Amount
Fixed-rate mortgages or auto loans have set interest rates. Adjustable-rate loans have changing interest rates.
By changing from an adjustable-rate to a fixed-rate loan, you can predict how much you owe each month. The predictable nature of your new fixed-rate loan may make it easier to create and stick to a monthly budget.
Con: You May Pay More Than the Initial Value
It is possible you may want to extend your loan term. Doing so may lower your monthly payments, but it also causes you to have to pay more interest.
That is often counterproductive, especially in the case of a vehicle loan. By the time you pay the new loan entirely, you may have paid more than the initial vehicle value.
Con: Refinancing a Mortgage May Negatively Impact Your Home Equity
If you want to refinance a mortgage, you may opt to do a cash-out refinance. That allows you to borrow from your home value.
Doing so can be useful when you need immediate cash. However, the long-term impact may not be worth the short-term benefit to you.
Con: The Act of Refinancing is Not Always Cost-Effective
Lenders often charge a lot of fees associated with refinancing. Closing costs and other fees may make the savings you get immediately or overall from refinancing minimal.
It is also possible you may not save anything at all, either immediately or by the end of the loan term. Evaluate any potential short-term or long-term savings potential before signing a refinancing agreement.