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Refinancing doesn't reset the repayment term of your loan, but it does replace your current loan with a new loan. You may be able to choose from different offers for your new loan depending on your goals, including a longer or shorter repayment term.
How Does Refinancing a Loan Affect the Loan Term?
You can refinance a debt by taking out a new loan and using the proceeds to pay off a current debt. The new lender might pay your current creditor directly, or it could send you the money, which you'd use to pay off your current loan.
In either case, your new repayment term options can depend on the type of loan, the lender, the loan amount and your creditworthiness. If you can choose between a shorter- and longer-term loan, consider:
- A shorter term could help you qualify for a lower rate and mean you'll pay off the debt sooner, but it will also lead to a higher monthly payment.
- A longer term can lower your monthly payments, but results in paying more interest overall.
There are pros and cons to both options, and the best choice will depend on your current financial situation and goals.
Is It Possible to Refinance Without Restarting Your Loan Term?
Because refinancing involves taking out a new loan with new terms, you're essentially starting over from the beginning. However, you don't have to choose a term based on your original loan's term or the remaining repayment period.
For example, if you're refinancing your mortgage, you may find that the top mortgage refinance lenders offer several repayment terms, including 10-, 15- and 30-year terms. You might choose to "restart" with the same term you originally had, perhaps 15 or 30 years—but that's not required. You may decide on a shorter or longer term depending on the corresponding interest rate and monthly payment.
When Does It Make Sense to Refinance a Loan?
Refinancing a loan can make sense when you can save money by paying less interest, free up room in your budget by lowering your monthly payment, or change other terms of your loan. Generally, you may want to look into refinancing when:
- Market interest rates have dropped
- Your credit has improved
- You have a variable-rate loan and want to lock in a fixed rate
- You can lower your monthly payments
- You want to remove a cosigner from a loan, such as a parent from a student loan or a former spouse from a mortgage
Saving money is a common goal. However, if you're looking into refinancing because you're having trouble affording your payments, also ask your lender about hardship options. Lenders may offer to temporarily or permanently modify your loan's interest rate, term or other specifics without refinancing. But generally, this only happens when borrowers are experiencing a hardship and have trouble affording their regular payments.
Your decision can also depend on the type of loan you want to refinance and the cost involved. Watch out for the following:
- Personal loans may have application and origination fees, while credit cards often charge balance transfer fees.
- For secured loans, such as a mortgage, see if there will be closing costs that you need to pay or add to your loan amount.
- Your current lender may charge a prepayment penalty or fees if you pay off the loan early.
Say you have a $5,000 personal loan at a 16% annual percentage rate (APR) with 36 months remaining and there's no prepayment penalty. Refinancing with a fee-free personal loan at 13% APR and the same 36-month repayment term lowers your monthly payment from about $176 to $168, saving you about $263 overall.
However, if the lender charges a 5% origination fee, you'll repay $5,250 at 13% APR over 36 months. Even with the lower interest rate, your monthly payment goes up by about $1, and you pay about $40 more overall.
Here are a few key points to keep in mind if you're considering refinancing different types of debt:
- Credit cards: You may be able to refinance credit card debt with either a balance transfer credit card or a loan. Balance transfer cards may offer an introductory 0% promotional APR before switching to a standard APR. A personal loan will charge interest from the start, but may be a better option if you'll need more time to pay off the balance, especially if you can qualify for a personal loan without an origination fee.
- Personal loans: Refinancing a personal loan with a new personal loan can be a fairly straightforward process. However, be careful about refinancing an unsecured loan with a secured debt, such as a home equity loan or line of credit that uses your home as collateral. Creditors can repossess or foreclose on your property if you miss too many secured loan payments.
- Auto loans: Auto loan refinancing options can depend on your finances, the lender and the vehicle's current value. The process may be similar to when you took out an auto loan for the purchase, but watch out for prepayment penalties on your original loan.
- Student loans: Private student loans generally don't have origination or prepayment fees. If you have private student loans, refinancing with a lower-rate student loan can be an easy way to save money. But refinancing federal loans with a private loan brings up all sorts of pros and cons. Even if you can lower your interest rate, your loan will no longer be eligible for special federal protection, forgiveness and repayment programs.
- Mortgages: Low mortgage rates often make headlines because refinancing a mortgage can lead to significant savings. A cash-out refi also lets you tap into the equity you've built in the home. In either case, be mindful of the closing costs as it can take several years to break even; refinancing might not make sense if you plan to move soon.
How Does Refinancing Affect Your Credit?
Credit scores don't consider the interest rate or repayment term of your accounts, and refinancing generally has a minor impact when you're replacing a loan with a new loan of the same type. But here are a few reasons why you may see your scores change:
- Opening a new account: Adding a new account to your credit report can lower the average age of your accounts, which may also hurt your score. However, making your new payments on time can help your credit.
- Closing accounts: The accounts you pay off will generally be closed, which can sometimes hurt scores. But your closed accounts can stay on your report for up to 10 years and continue to impact age-related scoring factors during that time.
- Hard inquiries on your credit report: When you apply for a new loan, the creditor will check your credit, causing a hard inquiry to appear. These may hurt your credit scores, although the impact is small and temporary.
One exception is when you refinance or consolidate credit card debt with an installment loan, such as a personal loan. Moving revolving debt to an installment loan can lower your credit utilization rate, which can have a significant, positive impact on your scores—as long as you don't run up balances on the cards you just paid off.
Prepare Your Credit for Refinancing
Whatever your motivation for refinancing, having good credit can be important when you want to get approved for a new loan. You can check your Experian credit report and FICO® Score☉ for free, and get insight into what's hurting and helping your score. Then focus on improving your score to help you get the best offer when refinancing a loan.