Debt

Debt Refinancing Fully Explained

Having a large amount of debt can feel like an unreasonably heavy burden. 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. 

Debt 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 debt 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 Debt Refinancing?

Debt 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 onto. 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 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 Debt 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.

Deft refinancing or consolidation is not available or the right option for every borrower as a better than average credit score might be necessary to qualify for lower interest rates. However, it could be a good financing option for those who can qualify 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 an excellent credit score 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, these types of loans 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 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 

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. 

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 larger portion of your repayment effort will go towards the principal balance since you have a lower interest rate. 

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 towards your principal balance. 

Doing this will put you in a mindset of aggressive debt repayment. You will be on the look out 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

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

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. 

References:
What Does It Mean to Refinance a Loan? | ValuePenguin