Managing your debt can be tough and that is why you might consider refinancing at some point. You want to use debt wisely, getting low-interest rates, taking on the right amount of debt for your income level, and building your credit score, but that’s easier said than done.

Many borrowers turn to refinance when they’re struggling with debt repayment. But there are many factors to consider when refinancing a loan. Make sure you understand the potential effects of refinancing before you act.

• Why Should you consider Refinance?
• Will Refinancing my Home hurt my Credit Score?
• Why Refinancing is a bad idea?
• Is it a Good idea to Refinance a Car Loan?
• What Happens if I back out of a Refinance?
• What are the Downsides to Refinancing?
• How long Should you wait to Refinance your car?

Why Should you consider Refinance?

When you refinance a loan, you’re essentially taking out a new loan to pay off an existing loan. The goal is to make your debt more manageable by applying new repayment terms. Think of refinancing as hitting the restart button on a loan.

Read Also: Cost to Refinance Home Loan

There are many types of loans that can be refinanced for lower interest rates, longer repayment terms, or lower monthly payments. These include:

• Mortgages
• Car loans
• Credit card accounts
• Personal loans
• Small business loans

The ultimate goals of refinancing are dependent on the type of loan you’re replacing. For example, refinancing a mortgage might result in a higher interest rate but a lower monthly payment. If you’re looking for lower monthly payments, the higher interest rate might be worth it. However, you’ll end up paying more over the life of your loan.

Will Refinancing my Home hurt my Credit Score?

When it comes to mortgage refinancing, your credit score probably won’t be negatively impacted unless you’re a serial refinancer. Like anything else, moderation is key here. When you refinance your home loan, the bank or mortgage lender will pull your credit report and you’ll be hit with a hard credit inquiry as a result.

It’ll stay on your credit report for two years, but only affect your scores for the first 12 months. The credit inquiry alone won’t necessarily lower your credit score, but if you’re constantly refinancing and/or applying for other types of new credit, the inquiries could add up to a point where they’re deemed unhealthy.

The credit score scientists found out long ago that individuals who apply for a ton of new credit are often more likely to default on their obligations. But that doesn’t mean you can’t apply for mortgages and other types of credit if and when you feel it’s necessary.

• All 3 of your credit scores may fall temporarily
• As a result of a mortgage refinance application
• But the impact is usually quite minimal, say only 5-10 points
• And fleeting, with score reversals happening in a month or so

Because a mortgage refinance is a new credit application, your credit score(s) could see a bit of a ding, though it probably won’t be anything substantial unless you’ve been applying anywhere and everywhere for new credit.

By a “ding,” I mean a drop of 5-10 points or so. Of course, it’s impossible to say how much your credit score will drop, or if it will at all, because each credit profile is completely unique.

Simply put, those with deeper credit histories will be less affected by any credit harm related to the mortgage refinance inquiry, while those with limited credit history maybe see a bigger impact. Think of throwing a rock in an ocean vs. a pond, respectively. The ripples will be a lot bigger in the pond.

But in either case, the ripple shouldn’t be much of a ripple at all, and nowhere close to say a late payment because it’s not a negative event in and of itself.

• FICO ignores mortgage-related inquiries made in the 30 days prior to scoring
• And treats similar inquiries made in a short period (14-45 day window) as a single hard inquiry
• Instead of counting multiple inquiries against you for the same loan
• This may help you avoid any negative credit impact related to your mortgage search

First off, note that when it comes to FICO scores, mortgage-related inquiries less than 30 days old won’t count against you. And for mortgage inquiries older than 30 days, they may be treated as a single inquiry if multiple ones take place in a small window.

For example, shopping for a refinance in a short period of time (say a month) may result in a large number of credit pulls from different lenders. But they will only count as one credit hit because the credit bureaus know the routine when it comes to shopping for a mortgage.

And they actually want to promote shopping around, as opposed to scaring borrowers out of it. After all, if you’re only looking to apply for one home loan, it shouldn’t count against you multiple times, even if you inquire with multiple lenders.

This differs from shopping for multiple, different credit cards in a short period of time, which could hurt your credit score more because you’re applying for different products with different card issuers. Even if you shop for a mortgage refinance with different lenders, if it’s for the same single purpose, you shouldn’t be hit more than once.

However, note that this shopping period may be as short as 14 days for older versions of FICO and as long as 45 days for newer versions. If you space out your refinance applications too much you could get dinged twice. Even so, it shouldn’t be too damaging, and certainly not enough to prevent you from shopping for different lenders.

The potential savings from a lower mortgage rate should definitely trump any minor credit score impact, which as noted, is short-lived. The mortgage, on the other hand, could stay with you for the next 30 years!

Why Refinancing is a bad idea?

Mortgage refinancing is not always the best idea, even when mortgage rates are low and friends and colleagues are talking about who snagged the lowest interest rate. This is because they can be time-consuming, expensive at closing, and will result in the lender pulling your credit score.

Before you begin the long process of gathering pay stubs and bank statements, think about why you are refinancing. While some financial goals—such as easing your monthly cash flows, dealing with a financial emergency, or paying off your home loan sooner—can be met with a refinance, here are seven bad reasons to refinance your mortgage.

1. To Consolidate Debt

Consolidating debt is often a good thing, but it has to be done right. In fact, debt consolidation done wrong can end up being one of the most dangerous financial moves any homeowner can make. On the surface, paying off high-interest debt with a low-interest mortgage seems like a smart move, but there are some potential pitfalls.

First, you are transferring unsecured debt (such as credit card debt) into debt that is backed by your home as collateral. If you are unable to make your mortgage payments, you can lose that home. While nonpayment of credit card debt can have negative credit score consequences, they are usually not as dire as a foreclosure.

Second, many consumers find that, once they have repaid their credit card debt, they are tempted to spend again and will begin building up new balances that they will have more trouble repaying.

2. To Move into a Longer-Term Loan 

While refinancing into a mortgage with a lower interest rate can save you money each month, be sure to look at the overall cost of the loan. For instance, if you have 10 years left to pay on your current loan and you then stretch out the payments into a new 30-year loan, you will end up paying more in interest overall to borrow the money and be stuck with 20 extra years of mortgage payments.

3. To Save Money for a New Home 

As a homeowner, you need to make an important calculation to determine how much a refinance will cost and how much you will save each month. If it will take three years to recoup the expenses of a refinance and you plan to move within two years, that means despite the lower monthly payments, you are not saving any money at all.

4. To Switch from an ARM to a Fixed-Rate Loan

For some homeowners, this can be an excellent move, particularly if you intend to stay in the home for years to come. But homeowners who are simply afraid of the bad reputation of an adjustable-rate mortgage (ARM), should carefully look at their ARM terms before making a move to refinance.

If you have an ARM, make sure you know what index it is tied to, how often your loan adjusts, and even more important, your caps on the loan adjustments: the first cap, the annual cap, and the lifetime cap. It may be that a fixed-rate loan is better for you, but make sure you do the math before committing to spending money on a refinance. 

5. To Take Cash Out for Investing

Even when the stock market isn’t rocky, this is not a generally good idea. The problem with cash is that it is too easy to spend. If you are disciplined and will truly use the extra money to invest—or to build your emergency fund—this can be a good option.

However, paying down a mortgage at 4% per year can be a better deal than plunking your cash into a CD that earns 2% every year. Make sure you are a savvy investor who understands both the risks and potential upside before playing with the equity in your home.

6. To Reduce Your Monthly Payments

In general, reducing your monthly payments by lowering your interest rate makes financial sense. But don’t ignore the costs associated with refinancing. In addition to the closing costs and fees, which can range from 2% to 3% of your home loan, you will be making more mortgage payments if you extend your loan terms.

If, for example, you have been making payments for seven years on a 30-year mortgage and refinance into a new 30-year loan, remember that you will be making seven extra years of loan payments. The refinance may still be worthwhile, but you should roll those costs into your calculations before making a final decision.

7. To Take Advantage of a No-Cost Refinance

A “no-cost” mortgage loan does not exist, so be careful when you see such an offer. There are several ways to pay for closing costs and fees when refinancing, but in every case, the fees are paid in one way or another. In other words, homeowners can pay cash from their bank account for a refinance, or they can wrap the costs into their loan and increase the size of their principal.

Another option is for the lender to pay the costs by charging a slightly higher interest rate or including closing points. You can calculate the best way for you to pay the costs by comparing the monthly payments and loan terms for each scenario before choosing the loan that works best for your finances.

Is it a Good idea to Refinance a Car Loan?

Refinancing can be an appealing way to lower your auto loan costs. Putting a little extra cash in your pocket can help with your monthly budget or save for the future. However, it’s important to understand the risks that are also involved with refinancing your auto loan.

When you refinance your auto loan, you’re paying off the balance on your original loan and replacing it with a new loan. Oftentimes, this requires you to change lenders, since most lenders will not refinance its own loan. However, refinancing your auto loan can help you if you want to lower your monthly payments or even adjust your loan term.

So when does it make sense to refinance your car loan?

1. Lowering your interest rate

There are a multitude of reasons that you could be stuck with a higher interest rate on your auto loan, but at the end of the day, it could be costing you hundreds or thousands of dollars over the life of the loan.

For example, let’s say you borrow $20,000 for a vehicle with an interest rate of 6% and a 60-month term. Over the life of the loan, you would pay nearly $3,200 in interest. Now, if you took the same loan and term, but had an interest rate of 3%, you would pay a little under $1,600 in interest over those five years. While it may not seem significant when you’re taking out the loan, interest adds up as time goes on.

2. Lowering your monthly payment

If you’re suffering from a high monthly car payment, refinancing can help you lower the month-to-month cost. The longer you’ve been paying on your original loan, the lower your principal balance is — meaning that if you were to begin a new term with that balance, the remaining funds would be spread out over a new amount of time. Your monthly payment can be lowered if your loan term is extended, if the lender offers you a lower interest rate or both.

“This is typically why we see borrowers choose to refinance,” adds Alyssa Inglis, a credit union lending officer. “Having a smaller monthly payment can help with budgeting.”

3. Removing or adding a co-borrower

The only way to remove or add a co-borrower from a loan is to refinance under the name or names of the individuals who should be on the loan. A common reason to remove a co-borrower is if an individual could not get approved based on their own credit history, so they had a co-borrow. Now the individual has built up their credit history, however, and is confident that they could get approved on their own without having the co-borrower.

What Happens if I back out of a Refinance?

When you refinance your home, you will find the application and processing to be very similar to the initial mortgage process. If you crunch the numbers and decide you need to back out of a refinance before everything is settled, it’s not the end of the world. Although it’s a stressful situation for you, the professionals involved with the loan know how to cancel the process.

Loan Processing Period

This is the period when the lender works to satisfy conditions for approval and process your loan. Common documents that the lender will gather include a real estate appraisal to determine the value of your home, title search to order title insurance, employment verification, real estate inspection and a statement of the current mortgage to facilitate a payoff of the mortgage.

If the lender proceeds through these processes, you will likely incur expenses by canceling because the lender will charge you for work already done to process the loan.

Application Fee

Lenders often charge a general application fee to cover processing costs and the cost involved with checking your credit score. If you cancel a refinance before the closing, you should expect the application fee to be nonrefundable. According to Bank.com, the credit report fee can cost $25 to $100, while the general mortgage application fee can cost as much as $500, depending on the lender.

Closing Costs

The closing is the meeting where you meet with representatives of the lender and the title company to sign loan papers. If you decide at the closing that you don’t wish to go through with the refinance, simply do not sign the papers.

You should expect to pay the expenses incurred from the loan approval process – appraisal, title search and inspection – as well as the application fee and possibly even closing fees if you back out of the refinance at the closing.

Rescission Period

The rescission period is a three-day period during which the buyer can cancel the loan. The clock starts to run from the time of the closing. If you decide to cancel during the rescission period, expect to pay all the same charges and fees that you would pay if you cancel earlier.

You may incur an additional charge by waiting to cancel until the rescission period because by this time the title company has completed the title work and issued the title insurance. Lenders do not typically disburse funds for a mortgage and a refinance until after the rescission period ends.

What are the Downsides to Refinancing?

There are a lot of advantages to refinancing your mortgage. But what about the downsides? Are there any disadvantages borrowers need to be aware of before taking out that new loan?

As with most decisions in life, there are both positives and negatives to refinancing a mortgage. Even with interest rates as low as they are right now, there are still potential pitfalls to avoid. Fortunately, most of these can be avoided by choosing the right mortgage – only a few are outright deal-breakers.

Here are some of the main things to look out for.

Cost

The number one downside to refinancing is that it costs money. What you’re doing is taking out a new mortgage to pay off the old one – so you’ll have to pay most of the same closing costs you did when you first bought the home, including origination fees, title insurance, application fees and closing fees.

These days, you’ll likely have to pay for a new appraisal as well, since most homes have declined in value over the past few years and the new lender will be unwilling to loan you more than the property is worth – they’d rather leave that burden on your current lender!

Refinancing will generally cost you from 2 – 6 percent of the amount borrowed, depending on where you live, though most borrowers tend to pay toward the lower end of that range. The key then, is to make sure you’re saving enough by refinancing to make the transaction worthwhile.

Not saving enough

So how do you know if you’re saving enough by refinancing? If you can recover your closing costs in a reasonable time. If your new mortgage rate is only half a percentage point lower than the old one, it might take 7-10 years to recoup the costs of refinancing. The general rule of thumb is that you want to save a full percent or more to make refinancing worthwhile, depending on how much your closing costs were.

The way to tell if you’re saving enough is by calculating your “break-even point” – how long it will take your savings from a lower mortgage rate to exceed your closing costs. You can use a refinance break-even calculator to determine how long this would be.

You generally want to be able to recoup your costs within five years or so. Many homeowners relocate after 5-7 years in the same property, so if you move before you reach the break-even point, you won’t recover your refinance costs. But if you expect to stay in the home for a long time, you can allow more time to reach your break-even point.

Stretching it out

If you’ve had a 30-year mortgage for a number of years, you probably don’t want to refinance your home into a new 30-year loan. That might lower your monthly payments, but it also postpones the day you own your home free and clear. And because of the way compounding interest works, it could cost you more over the long term, even if you reduce your mortgage rate in the process.

It’s better to choose a 15-, 20- or 25-year term that more closely matches the time you have left on your original home loan.  And since shorter-term loans have lower mortgage rates, you can often chop a few years off your loan without increasing your monthly payment.

A “no-cost” refinance could cost you

Some mortgage lenders advertise what they call a “no-cost” refinance, where there are no separate charges for closing costs. But a no-cost refinance isn’t free; the lender charges a higher mortgage rate to compensate.

A no-cost refinance can be attractive if you’re short on cash and don’t want to pay your closing costs out of pocket. But over time, that higher interest rate adds up.

A no-cost refinance might be advantageous if you expect to sell the home or refinance within a few years.  But over 10-30 years, you’ll likely pay a lot more in mortgage interest than you’d save in closing costs.  So keep that in mind. Use a mortgage calculator to figure how much more you’d be paying in interest every year and how long it would take that to exceed the closing costs you’d save.

Getting too aggressive

Refinancing to a 15-year fixed-rate mortgage can be attractive, with their very low rates and the prospect of paying off your mortgage much faster. However, a shorter term also means paying more in principle each month, which can significantly increase your payments. Don’t bite off more than you can chew.

Refinancing too often

When mortgage rates are falling, borrowers sometimes fall victim to the temptation to chase after ever-lower rates, refinancing each time rates drop by a quarter or half a percentage point. And each time, they pay a new round of closing costs that eats into or even exceeds their savings from refinancing. As mentioned above, a good rule of thumb is to wait until rates have fallen at least a full percentage point below your current rate before refinancing.

Don’t rush with this. It’s paramount to wait a little longer to get the best deal as the savings made will be far greater. 

Moving on too soon

There’s not much point in refinancing a home you’re planning to move in a few years. The same is true for when you’ve only got a few years of payments left on your mortgage.

If moving to a new home is part of your intermediate-range plans, you may not be in the current one long enough to see much of a gain from refinancing. If it’s going to take four years to reach your break-even point (the point where your accumulated savings in interest exceed your closing costs) and you expect to move in about five, you have to wonder if refinancing would be worthwhile.

Similarly, if you’ve only got a few years left on your existing mortgage, you might not save that much in mortgage interest even with the best refinance rates. The share of your monthly mortgage payment that goes toward interest falls rapidly in the latter years of your loan, so the potential savings are reduced as well.

Note that these are for situations where you refinance to reduce your mortgage rate; there might still be advantages to a cash-out refinance or refinancing to extend your term and reduce your payments in such situations.

How long Should you wait to Refinance your car?

The short answer is whenever you want. But there are more factors at play than just timing. You must be sure the numbers work out in your favor, and you must approach a refinance with every advantage available to you.

Getting a Good Deal

If you financed the purchase of your vehicle and you don’t feel you got the interest rate you deserve or the terms you need, refinancing could be a good move. Technically, you can try for a better loan any time you want — even before you’ve made a single payment!

Keep in mind, however, that obtaining the auto loan you already have — and the hard inquiries generated by that process — probably caused your credit score to take a temporary dip. If you are immediately tempted to shop for a refinance, check your credit first. It might be worth waiting a few months to let your score recover.

Another factor to consider is the amount you owe compared to the value of your vehicle. While there is no hard-and-fast rule about how or when banks and finance companies refinance loans, they are much less likely to put up the money to buy out your original loan if your vehicle isn’t worth at least as much as they are paying for it.

If you do find a finance source willing to refinance you at this stage, they are doing so at considerable risk. That risk can affect your new interest rate, so it is wise to wait until your negative equity has been paid off.

Your Payment History

If you are looking to refinance an auto loan for a vehicle you bought more than a year ago, your credit score is not the only factor at play. You will have to back up your score with a solid payment history.

When your new finance source pulls your credit report and sees that you’ve made every single payment on time, every time, for a good chunk of time, they are going to view you as less of a risk and will be more willing to work with you on terms and rates.

While there is nothing to stop you from trying to refinance at any time, it is generally better to wait at least a short period of time.

Here are some rules of thumb to guide you on when to refinance your auto loans:

• Wait at least 60-90 days from getting your original loan to refinance. It typically takes this long for the title on your vehicle to transfer properly, a process that will need to be completed before any lender will consider your application. Refinancing this early typically only works out for those with great credit.
• Consider refinancing after six months. If you have fair to great credit, you will begin to have refinancing options after this length of time.
• If you are a first-time car loan borrower, wait at least a year to refinance your loan. A first-time borrower typically needs to build up a good car loan payment history before refinancing.

Before you jump in, it might be a good idea to think about what you hope to get out of refinancing.

Final Thoughts

If you’re not willing to lower your credit score to refinance a loan, there are other options available to you. 

Read Also: Structured Settlement Loan

The simplest option for mortgages is recasting your loan. With the help of a professional, you can examine your finances to discover the ideal monthly payment that will satisfy your loan principal and cut down on your total interest payments. This works when you need to pay off a loan faster.

If you’re looking to free up funds, you can borrow against the equity of a loan such as your mortgage. However, this creates its own set of pros and cons.

While refinancing a loan will have a temporary effect on your credit score, it might be worth it for your particular situation. Just make sure you make an informed decision that’s right for your current and future self.