Disclaimer: Upstart is not a financial advisor, the following content is for informational purposes only.
Any form of debt can be a drain on your budget, but high interest debt can weigh extra heavy. Naturally, you might wonder: Is it worth to refinance my current loan or, is it better to stick with what I’ve already got?
The short answer: it depends.
A refinance, also known as “refi,” is a process that offers you the chance to lower your loan interest rate, reduce your monthly payments, and can potentially help you save money. By refinancing your loan through a lender, you’re essentially trading in your current loan(s) for a new loan with better terms.
While refinancing can be a good financial move for some borrowers, it may not be for everyone. To help you decide if it’s right for you, we’ll cover when it’s best to refinance and the pros and cons to consider.
When to refinance
Refinancing a loan can make sense if it’ll help you save money. For example, let’s say you took out a loan to help finance your new car and your financial standing has improved since then. You could refinance your car loan to try and qualify for a lower rate. If you get a lower interest rate, you can save a lot of money in interest over the life of your loan. We’ve put together some scenarios when you may want to consider refinancing a loan.
Your credit score has improved.
Good for you! That shows you’ve worked hard to improve your financial standing and lenders will notice. A majority of lenders use credit scores to help them understand how well you’ve paid past debts and assess their risk in loaning to you. If you’ve paid back money you’ve borrowed in full and on time in the past, the better your credit score will be. Lenders are typically more likely to give more favorable interest rates to borrowers that have a higher credit score.
If you’ve improved your credit score since you initially got a loan, then this could be a good time for you to refinance since you’ll likely qualify for a lower interest rate.
You don’t want to pay a balloon payment
Depending on the type of loan you have, you may be required to make a balloon payment. What is a balloon payment? It’s a big one-time payment made at the end of a loan term. Since a balloon payment is more than two times a typical monthly payment, you may want to refinance your loan before that payment drops. Especially if you’re not sure you can make that payment when it’s due.
Your monthly payments are too much
If you’ve lost your job or experienced a pay cut since you took out your loan, lower monthly payments can look good to you. You could refinance your loan and opt to increase the length of your repayment term. A longer repayment term might not save you money over the life of your loan, but it’ll help lower your monthly payments.
You want to change the type of rate you have
There are two types of interest rates: fixed and variable. With a fixed rate, the amount you pay in interest stays the same over the entire time you repay the loan. That means your monthly payments are always the same.
Variable interest rates are the opposite—they can increase or decrease over the life of your loan depending on fluctuations in the market. That means your payments can vary as well.
If you currently have a loan with a variable interest rate and you’re struggling to budget and plan your monthly payments, consider refinancing your loan to get a fixed rate and a more consistent payment schedule.
You can pay for the fees comfortably
Refinancing a loan with a current or a new lender usually requires fees like an origination fee or application fee. Before you commit to refinancing your loan, ask your lender about their fees so you better understand how much it’ll cost. Once you’re done factoring in fees, you can decide if refinancing is the right financial decision for you.
You want to pay off your loan faster
As long as you’re comfortable making larger monthly payments, you can refinance your current loan and shorten the length of the repayment period. Why? You could save a lot of money over your loan term in interest.
Pros and cons of refinancing
Before you run to your bank for refinancing, you may need to weigh the potential costs and disadvantages.
To help you make the best decision for your financial situation, we’ve gathered the top pros and cons of refinancing.
What are the pros of refinancing?
- Ability to save money: You can save money by refinancing your current fixed rate loan into a variable rate loan when interest rates drop. A refi can also save you money if your credit score has improved because it may help you qualify for a lower interest rate.
- Shorter and/or longer repayment periods: If your financial situation changes for better or for worse, you may need to adjust your loan repayment period, which you can do through a refi. If you’d like to complete your loan payments sooner rather than later, you can refinance to shorten the length of the loan term. On the flip side, if you’re struggling financially, you can refinance your loan to extend the repayment term, which will lower your monthly payment amount.
- Payment predictability: It’s easier to budget and achieve financial goals if you’re able to account for every aspect of your financial standing, including all monthly loan payments. If you have a variable rate loan, you can refinance your loan to get a fixed interest rate, so your monthly payments are exactly the same.
What are the cons of refinancing?
- Added fees: When you take out a new loan, even a refinance loan, there’s a chance your lender may charge you additional fees—such as an origination fee, application fee or prepayment penalty. If your lender charges any of these fees, it’ll increase the cost to refinance, which could end up being more than it’s worth since it’ll cut into any possible savings you may get.
- Possible increase in interest costs: If you refinance your loan to get a longer repayment term, it can lower your monthly payments but it may cost you more in the long run because you’ll have more interest costs.
- Long process time: Researching for lenders, filling out applications, and qualifying for a loan refinance takes time. If you have a time crunch or you’re close to paying off your loan completely, it might not be worth it to go through the process.
The bottom line: Circumstance is key
Refinancing can take a lot of time and effort. Before you start to research your options, do a deep think about your financial standing. Take the information we’ve gathered to help you understand whether the refi pros truly outweigh the cons for you.
If your financial situation could use some improvement, consider a few steps to improve your credit score before you apply for a refi. If you decide you’re ready, you can start by checking out what Upstart has to offer.