There are times when paying your loans off seems impossible, especially when you are dealing with a loan that has high rates and you wind up paying thousands in interest over the course of its life.
Loan refinancing is a process that allows you to take out a loan to pay off your current outstanding loans. Refinancing gives you new loan terms that lower your interest rates, reduce your total payment amount, or gives a longer loan term with reduced payments.
What Is The Difference Between Loan Refinancing And Debt Consolidation?
The idea behind loan refinancing may sound familiar. Debt consolidation is another form of debt relief that can help you pay off your debt by taking out a new loan, but there are a few key differences between the two:
- The main purpose of loan refinancing is to get a lower interest rate, while the main purpose of debt consolidation is to combine your debts into a lump sum to pay it off over time with a lower interest rate.
- Federal and private loan consolidations also have a few notable differences:
- The interest rate for federal debt consolidation is determined by the average of all the loans you consolidate.
- Private debt consolidation helps you get a lower interest rate that is based on your credit score and not your previous interest rates.
- If you have good credit, you should qualify for a loan with low interest rates; if your credit is bad, you will have to find a lender who offers bad credit personal loans with reasonable rates.
- Student loan consolidation is offered by the Department of Education and combines your federal student loans into one single loan through a free program.
- Most borrowers prefer to consolidate federal loans and refinance private loans.
What Are The Different Types Of Loan Refinancing?
There are several types of loans that can be refinanced:
- Student loans: Student loan refinancing is a particular type of refinancing that has been growing in popularity. Student loan refinancing is specifically used for private loans, which do not have the same flexibility as federal loans. Federal loans offer income-based repayments, graduated plans, and extended plans that allow you to change your repayment plan simply by contacting your lender or logging into StudentLoans.gov.
- Credit cards: Taking out a personal loan with a lower interest rate can be used to pay off your high-interest credit card debt.
Mortgages: Borrowers can refinance mortgages to lower their monthly payment or reduce their term length from a 30-year term to a 15-year term to pay off the loan quicker and minimize the amount of interest paid.
If you took out an FHA, which has a low down payment, you will pay a higher mortgage insurance than other mortgages that only require insurance until you hit 20% equity.
Unfortunately, mortgage refinancing has high closing costs so it may not be worth the cost in the long run.
- Auto loans: Borrowers may choose to refinance their auto loan in order to lower the monthly payment. There are some requirements and restrictions, such as the age of your car, its mileage, and outstanding balance limits.
- Small business loans: SBA 504 loans can be used to refinance real estate loans to lower interest rates and your monthly payment. These loans can also be used to purchase equipment and real estate.
When To Refinance Your Loans
Refinancing your loan is a big step towards restructuring your finances and although it can be helpful, the benefits of loan refinancing depends greatly on your personal situation and may not be the best choice for everyone. Loan refinancing might be your ideal option under the following circumstances:
- You can pay off your loan faster by shortening the loan term.
- You can save 1% or more on your interest rate and you are not adding extra time to your loan term.
- You want to refinance multiple private loans after graduating into one easy-to-pay plan.
- You have federal student loans on the 10-year plan and you don't qualify for income-based repayment plans or forgiveness.
- You can refinance a loan with high variable rates to a loan with steady fixed rates.
- You have good credit and you can refinance a high-interest federal loan.
- You may choose to refinance your loan to release a cosigner from the responsibility of taking care of any payments you miss and negatively affecting their credit.
However, there are times when pursuing loan refinancing may not be worth your time:
- Instead of loan refinancing, you can use student loan consolidation to consolidate multiple federal student loans.
- You are able to release a cosigner from your loan without refinancing.
- Those who work in public service can qualify for Public Service Loan Forgiveness after 10 years of payments and the government will forgive your loan. Refinancing your loan means you can't use federal student loan forgiveness.
- You are able to use income-based repayment plans.
- You have no need to change your private loan repayment plan.
- You qualify for an income-driven repayment (IDR) plan, which caps your payment depending on your income and extends your repayment term. This means you will lose your IDR plan if you refinance your loan.
- Refinancing a loan may not be worth the prepayment penalties that come with mortgages and car loans.
- Although you can refinance an already refinanced loan (if there aren't restrictions or prepayment penalties), this also means that your loan term becomes longer each time you refinance.
Where To Refinance Your Loans
If you decide to pursue loan refinancing, you should first compare your options with lenders. Most lenders who offer traditional loans also provide loan refinancing.
Once you submit an application and have been approved for loan refinancing, there are certain loan terms you should look for:
- Fixed and variable rates: Fixed rates tend to be higher because they remain the same during your loan. Variable rates start off lower, but they have a chance of increasing depending on the economy.
- The length of the loan: You must decide on loans between 5, 10, or 20 years. Longer loan terms have higher interest and short loan terms result in higher monthly payments.
- Hybrid loans: Some lenders offer hybrid loans that let you pay a fixed rate for the first 5 years and then switch to a variable rate.
- Additional features: Some lenders (like SoFi will offer certain protections in case you have trouble paying back your loan if you've lost your job.
- Discounts: Many lenders offer discounts such as a lower interest rate if you use autopay.
- Extra payments: If you choose to make extra monthly payments, some lenders may put that payment towards your interest instead of your principal. You can always contact your lender and request that extra payments are put towards your principal.
Refinancing Eligibility Criteria
Your eligibility is largely determined by your credit score and each individual lender.
Unfortunately, some lenders only offer student loan refinancing for those who have a degree, and many borrowers pursuing loan refinancing may not be eligible due to a low credit score or annual income. If you are struggling with a low credit score that prevents you from receiving loan refinancing, you can work on improving it with credit repair.
Our Top Refinancing Recommendations
SoFi initially began as a student loan refinancing lender before branching out to other financial services. They require a high credit score and income for loan refinancing (their average customer has an annual income of $150,000 and a FICO score of 770).
SoFi offers competitive low rates, flexible terms, fixed or variable rates, and an unemployment protection program. There are no origination fees, closing costs, or prepayment penalties.
Upstart requires you to have a degree or be ready to graduate within 6 months to qualify for Upstart. You can be considered for refinancing even with thin credit history as long as you have a minimum score of 640. Upstart borrowers usually have a low debt to income ratio and a high annual income.
Upgrade offer unsecured loans with fixed rates and determines if you have enough free cash flow by looking at your income, the cost of living in your area, tax rate, and your rent or mortgage.
EVEN Financial offers loan refinancing and are especially well-known for credit card debt refinancing.
Does refinancing a loan impact my credit?
Submitting an application for loan refinancing will generate a hard inquiry, which causes a small and temporary drop in your credit score. Loan refinancing may also impact your credit since your original loan will be paid off early and replaced by a new loan, thus reducing the age of your accounts.
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