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Debt refinancing fully explained

debt refinancing

Debt refinancing is the process of taking several balances and combining them into a single monthly payment. Consumers can refinance debts like loans, credit card balances, or other outstanding balances they may owe.  

Having a large amount of debt can feel like an unreasonably heavy burden. According to the Federal Reserve Bank of New York, the amount of total household debt for Americans reached $17.06 trillion as of the second quarter of 2023.1 When debt feels out of control, it can bring about a great amount of financial distress. There are many solutions that could lighten the burden of your debt obligations, one of which is refinancing. 

Refinancing can offer possible relief for borrowers struggling to afford their high-interest debt. Refinancing can prove an excellent solution for all kinds of debt, including personal loans, business loans, auto loans, mortgages, and credit card debt. 

To figure out whether refinancing is an appropriate solution for your debt troubles, we recommend understanding fully how refinancing works and how it is typically done. Once you have further knowledge of how to refinance loans and credit card debt, you can determine whether to move forward in your own refinancing plans.  

What Is Refinancing?

Refinancing refers, very broadly, to the act of acquiring a new loan or other debt instrument that offers you better terms than your previous contract so it is easier and/or more affordable to pay down your remaining balance. 

This broad terminology can apply to refinancing an existing loan with your current lender, applying for a new loan to pay off your old debt, or opening a new line of credit to transfer your existing debt. Refinancing can be used for a variety of purposes, with some of the most common being consolidation, getting lower monthly payments, reducing interest rates, or obtaining more money through a cash-out refinance. 

Refinancing Debt vs. Debt Restructuring

Refinancing and restructuring are not to be confused as they are two very separate processes. Even though they are sometimes used interchangeably, especially when it comes to business debt, it is important to emphasize that debt refinancing and modification/restructuring are wholly different ways of reorganizing debt. Debt restructuring refers to the alteration of an existing contract rather than an entirely new one (as is the case with refinancing).

Refinance Debt Through Your Current Lender

Refinancing your original loan through your current lender instead of applying for a new loan is more with mortgage and business debt. Homeowners who have seen an increase in their credit score since they first purchased their home might seek out a lower monthly mortgage payment or cash-out refinance on their home loan. When doing this, borrowers receive a new contract with new terms on their old loan.

Common Methods for Refinancing Credit Card Debt

When you have too much debt built up on your credit cards, your minimum payments could be wreaking havoc on your monthly budget. If your credit card balance is too high and your interest rate is skyrocketing, it might be a good idea to refinance that debt by consolidating it. 

Consolidating multiple credit cards into one loan, one card, or line of credit could give you access to more competitive terms and a single lower monthly payment that will make it easier to pay off your debt altogether. If you have other high-interest debt in addition to your credit cards, you might be able to lump all those balances together so you can tackle them all at once.

Credit card refinancing or consolidation may be good financing options for those who can qualify for more favorable terms.
Here are a few of the most common options used to refinance debt: 

Personal Loan for Debt Consolidation

Many borrowers apply for a personal loan for the purpose of debt consolidation. If you are approved for a large enough personal loan, the money you borrow can be used to pay off your credit card balances as well as any other debts you have left. Borrowers with excellent credit scores will have more favorable personal loan options available to them that will make refinancing worth it.

While there are personal loans for people with poor credit, often referred to as bad credit loans, they tend to have higher interest rates that may not be competitive with your original loan. However, some credit cards have variable interest rates that are incredibly high so it is a good idea to see whether personal loans could offer a better alternative, just in case. 

Balance Transfer Credit Card

A balance transfer card is a common way to refinance debt, and if you go about it the right way, you could end up saving a lot of money in interest payments. Putting all your credit card balances onto a single card will allow you to cut your many monthly payments down to a single monthly payment with a new interest rate. But if you use this method wisely, you could end up with no interest rate at all.

Some credit card companies give new customers a promotional offer of a 0% annual percentage rate (APR). A lot of these promotional offers last up to a year and, in some cases, 18 months. This could give you long enough to pay off the remaining balance of your debt. If you are able to pay off the balance before the promotional period ends, it will essentially be the equivalent of having interest-free debt repayment.

Home Equity Line of Credit / Second Mortgage Loan

If you are a homeowner, you could possibly use the equity in your home to access a significantly lower interest rate to refinance and consolidate your debt. A home equity line of credit or loan is secured by the cash built up in your home’s value, and secured debt tends to garner lower interest rates since they are less risky for lenders. It may also be possible to get a home equity loan with bad credit

Furthermore, you will need to have paid off a portion of your home loan already to have the equity to obtain a line of credit to consolidate your debt. If you have a fair amount of equity built up, you can get a line of credit big enough to cover all your debt obligations. Then you will only need to be concerned with one payment a month, and a larger portion of your repayment effort will go towards the principal balance since you have a lower interest rate. 

Breakdown of Common Refinanced Debts

CriteriaPersonal LoanMortgage RefinanceAuto Loan Refinance
Typical Interest Rates5% – 36%.2.5% – 5%.3% – 10%.
Impact on Credit ScoreA hard inquiry can temporarily reduce your credit score by a few points.Similar to a personal loan, a hard inquiry can slightly drop your score. Refinancing can lead to a temporary dip due to the credit check. 
Loan Term Options1 – 7 years.15, 20, 30 years. 2 – 7 years.
Primary UseDebt consolidation, major purchases, home improvement.Lower monthly payments, can change loan type, cash-out home equity. Lower monthly payments, change loan terms, get a better interest rate. 
Eligibility Factors Credit score, income, debt-to-income ratio.Credit score, home equity, loan-to-value ratio. Credit score, loan amount, age of vehicle. 

*The information provided in the above refinancing data table is for general informational purposes only and should not be considered as financial advice. Interest rates, terms, and other details can vary based on the lender, the borrower’s creditworthiness, and prevailing market conditions. Before making any refinancing decisions, borrowers should consult with a financial advisor or lending institution to obtain accurate and personalized information.

Tips for Paying off Your Debt

It might feel like your financial goals are out of reach when you are still struggling to pay off your debt. While it can be incredibly overwhelming when you are just starting out on your journey to financial freedom, it all comes down to putting one foot in front of the other. Doing the next best thing. 

If you are consistent with your efforts and persevere through the challenges you might face along the way, you are sure to be successful. To help you on your journey, here are some tips for a debt repayment strategy that actually works:

Make Extra Monthly Payments

Don’t stop at the typical and required monthly installments. Increase the amount of monthly payments you make by adding an extra one or two. This will make a minor difference in the amount of interest you are paying, making your payments go further toward your principal balance. 

Doing this will put you in a mindset of aggressive debt repayment. You will be on the lookout for ways in which you might redirect your cash flow to paying off your loans or credit cards. Once you have changed your mindset, the hardest part is behind you.

Check Your Credit Report

Periodically check your credit report throughout your debt repayment journey. Hopefully, you will begin seeing improvement in your credit score. But it’s a good idea to take advantage of the free annual report to see the changes as they happen. This will allow you to catch any errors or issues as they happen so they can be rectified immediately. 

You will want to double-check that your payments are showing up and the balance of your debt is going down. Your credit history should show the proof of your hard work.

Pay Off Your Loan Early to Save on Interest Payments

If possible, attempt to pay off your loan early. Whether you’ve refinanced your debt or not, you could still save money on interest by finding room in your budget to pay more than the required amount each month. Consider increasing your cash flow by taking on a side hustle or putting in some overtime. 

Paying off your loan early won’t only save you money but will also bring you an enormous sense of relief. Your payment history will look excellent, and you can begin rebuilding your credit profile sooner than planned.

Communicate With Your Lender About Your Monthly Payment 

While you are in the midst of the repayment process, stay in communication with your lender. If you ever come across any issues or are struggling to make a payment, reach out to them and explain what is going on. Being honest with your situation will make the lender far more willing to work with you because it communicates that you are committed to paying your debts. Don’t just miss a payment, as you could risk defaulting on the loan. Prioritize clear communication with your lender, and they will be more flexible. 

Refinancing FAQ

What are origination fees in the context of loan refinancing?

Origination fees are upfront charges by lenders when processing a new loan application. They cover the cost of processing the new debt and are typically a percentage of the total loan amount. When considering loan refinancing, it’s essential to factor in these fees to determine if refinancing is cost-effective.

How does a cash-out refinance loan differ from standard loan refinancing?

A cash-out refinance loan allows borrowers to refinance their current loan for more than they owe, taking the difference in cash. This can be useful for borrowers looking to leverage their home’s equity for significant expenses, but it might increase the monthly payments or extend the loan term.

What’s the difference between a fixed interest rate and a variable interest rate?

A fixed interest rate remains constant throughout the loan term, ensuring consistent monthly payments. In contrast, a variable or adjustable interest rate can fluctuate based on market conditions, which might affect the monthly payment amount.

Are there any closing costs associated with refinancing?

Yes, closing costs are fees and charges due when finalizing a refinance transaction. These might include appraisal fees, title searches, and other related expenses. It’s crucial to account for these costs when determining the potential savings from refinancing.

If I refinance, will it be considered a new debt on my credit report?

Yes, when you refinance, the current loan is paid off, and a new debt is established. This new debt will appear on your credit report, and the old loan will be marked as paid or closed.

What are prepayment penalties, and how do they relate to refinancing?

Prepayment penalties are fees charged by lenders if a borrower pays off a loan before its maturity date. If your current loan has prepayment penalties, you’ll need to consider these costs when deciding to refinance.

How can refinancing affect my monthly payment?

Refinancing can either increase or decrease your monthly payment, depending on the new loan’s interest rate, term, and amount. It’s essential to compare the current loan’s monthly payment with the proposed loan to determine the potential savings or costs.

How does my credit utilization ratio impact my ability to refinance?

Your credit utilization ratio, which is the percentage of available credit you’re using, plays a significant role in your credit score. A high ratio might indicate over-reliance on credit and could negatively impact your financial situation, making it harder to qualify for favorable refinancing terms.

Is it better to have fixed interest rates when refinancing?

Fixed interest rates offer stability in monthly payments, which can be beneficial for budgeting. However, the best choice depends on your financial situation, goals, and how long you plan to keep the loan. If you believe interest rates will rise, locking in a fixed rate might be advantageous.

How can I determine if refinancing is right for my financial situation?

To determine if refinancing is right for you, consider the potential savings from lower interest rates, changes in monthly payments, the costs of origination fees and closing costs, and your long-term financial goals. Consulting with a financial advisor can also provide personalized guidance.

A Word From CreditNinja on Refinancing

Refinancing can be a great way to consolidate debt, save money on interest rate payments, and make managing your overall debt so much easier. But, financial emergencies can always happen. If you need a loan that won’t derail your finances, consider personal installment loans with CreditNinja. CreditNinja borrowers often enjoy benefits like:  

  • Flexible monthly payments
  • Competitive interest rates
  • Bad credit score OK
  • Friendly customer service
  • Quick funding*

Check out our easy online application to see how much money you could qualify for today!

References:
1. Household Debt and Credit Report – FEDERAL RESERVE BANK of NEW YORK.

2. What Does It Mean to Refinance a Loan? | ValuePenguin

*Not all loan requests are approved. Approval and loan terms vary based on credit determination and state law. Applications approved before 10:30 a.m. CT Monday – Friday are generally funded the same business day. Applications approved after this time are generally funded the next business day. Some applications may require additional verification, in which case, the loan if approved, will be funded the business day after such additional verification is completed.

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