How to Save Money on Loan Interest by Refinancing or Consolidating
If you are hoping to save money on loan interest, there are a couple of things you can do, depending on what debt has the biggest interest rate you are trying to lower.
Figuring out the best way to deal with all of your personal bills is an important step towards reaching financial freedom. For example, you can save a lot of money on loan interest and that’s one of the best reasons to refinance in the first place. There are several ways to reduce the loan interest by refinancing.
You can refinance to the lowest interest rate so you are paying less on your loan balance.
You can also switch to a shorter loan term. This will mean higher monthly payments but you pay interest for less time.
You can use the loan to consolidate high-interest debts into low-interest debts.
The rule of thumb is to refinance if you can reduce the interest rate by 2%. However, lenders say that 1% of savings is also enough of an incentive to refinance. Not only do you save money on loan interest when you refinance but it can also increase the rate at which you build equity in the home.
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Refinancing Mistakes That Can Cost You
While refinancing can help you save money on loan interest, you need to be careful about making these mistakes that could cost you more money.
Skipping Out on Closing Costs
Remember, you are getting a new loan so this means you do have to pay closing costs to finish the paperwork. Closing can vary but usually, these costs are 3% to 5% of the loan value. There is an out with the form of a no closing cost mortgage. However, to make up from the money that the lender is losing upfront, they will charge a higher interest rate. Over the life of the loan, you will be paying more in interest, which defeats the purpose if you are trying to save money on loan interest.
Lengthening the Loan Term
If the only goal of refinancing is to lower the payments then stretching out the loan term definitely accomplishes this. The only problem is that you are then paying more in interest over the life of your loan.
Refinancing with Less than 20% Equity
Refinancing can actually increase your mortgage costs if you haven’t built up enough equity in your home. Generally, if you have less than 20% equity value, the lender requires you to pay private mortgage insurance. This insurance is protection for the lender against the risk that you default. Even if you are locked into a lower interest rate, the money added to your payment for the insurance is going to take away a lot of the savings you are seeing.
not finding the best place to refinance
You need to make sure you go to the best lender out there who will look at the information you provide them with and figure out the best option for you, and them. You don’t want them to put themselves first and not offer what’s best for you. This is why you need to do your research.
Other Benefits Of Refinancing
While saving money on loan interest can be a good benefit of refinancing, there are also some other benefits you may want to consider.
Reduce Your Risk
Refinancing can be a good idea even if you aren’t getting a lower rate. One example of this is getting out of an adjustable-rate mortgage. If you are worried that there could be big interest rate increases in the future then refinancing into a fixed-rate mortgage can reduce that risk. Even though monthly payments may increase, you will feel comfortable knowing the rate will never increase.
Cash Out Equity
Some homeowners choose to refinance to cash out on the equity in the home to pay for home improvements, education, or a new business. While these are all useful ventures, it’s important to be careful about a cash-out refinance if you are using it for some things. For example, a business can fail or the home improvements may not increase the value of your home as much as you thought. If you have to put your home on the line for anything then make sure you can keep up with the mortgage.
Remove a Borrower from the Loan
If you have bought a home with a friend or relative and you want to make a change to who is responsible then refinancing can be the right time to do this. The deed or title won’t automatically change when the mortgage does so you do need to remove the name from these documents as well.
Eliminate FHA Mortgage Insurance
If you bought your home with an FHA then there is mandatory mortgage insurance. These payments are made each month for the life of the loan. With a conventional loan, you can remove this once you have some equity in the home but with an FHA loan, you will have to refinance to a different type of loan if you want to stop paying mortgage insurance.
Refinance to Consolidate Debt
Some homeowners refinance to consolidate debt. At the face value, this makes sense. You are replacing high-interest debt with a low-interest mortgage. Refinancing may not always be the answer and can be a slippery slope to never-ending debt.
What To Pay Attention To When Refinancing
If you are thinking of refinancing to save money on loan interest, there are some things you need to pay attention to. It may be helpful to do a break-even analysis to see the loan terms you need to find in order to make the refinance worth it.
Closing Costs
The closing costs will add expenses to the loan. It’s possible that the closing costs can wipe out any gains you get from lowering your interest rate. Pay out of pocket for closing costs so you also aren’t paying interest on them.
Prepayment Penalties
You may have prepayment penalties on your current loan. Since you are paying off the loan early with a refinance, it may not be worth it if you do have prepayment penalties.
Private Mortgage Insurance
You may need private mortgage insurance if the home has lost value.
Nonrecourse Loan into Recourse Debt
Investigate whether you are turning your current nonrecourse loan, where no collateral is required, into recourse debt. If this is the outcome then a lender could garnish your wages or take another action against you if you happen to go through a foreclosure.
Whether Equity Changes
Taking out cash or adding some closing costs can reduce the equity in the property. If you just replace one loan with another one of the same size then equity remains the same.
How Long You Stay in the Home
It can take years to recoup some of the costs of refinancing so you don’t want to do it unless you plan on staying in the home for more than a few years.
Sometimes refinancing isn’t feasible or it’s not the best option. You can still get some of the benefits of refinancing without having to go through the process. If you want to save on your interest costs then pay more than the minimum that is required each month. This means you will get rid of the mortgage earlier and you spend less on interest over your lifetime.
Consolidating To Save Money On Loan Interest
Debt consolidating is a strategy where you merge multiple bills into a single debt that is then is paid off by a loan. Debt consolidation is useful for high-interest debt, such as credit cards. It can reduce the monthly payments since you have a lower interest rate, making it easier to pay off your debt.
How Does Debt Consolidation Work?
The first step in debt consolidation is calculating the total amount you are currently paying for your credit cards every month and other debts you want to include. Look at the average interest you are paying. This can give you a baseline number for comparison purposes. Next, you want to look at your monthly budget and see your basic necessities, such as housing and food. How much money is left will be the important answer. For some, there is enough money to handle debts if you organize your budget better and get motivated. Even if there is enough money left over and you can pay off your debt, you may want to consider debt consolidation to lower your interest rate significantly.
The conventional method to consolidate your debt is to get a loan from a credit union, bank, or online lender. The loan should be big enough to eliminate the unsecured debt at once. The loan will then be repaid in monthly installments at the interest rate you get with the lender. The repayment period is typically between three and five years but how much interest you are going to be charged is the key.
If you want to save money on loan interest by consolidating then you need a good interest rate. Lenders look closely at your credit score to determine the interest rate you will get for a loan. If you are falling behind on debt payments and need to consolidate then it’s likely that your credit score could be hurting. If the interest rate you can get for a loan isn’t lower than the average you are already paying then debt consolidation doesn’t help you.
It can also be possible to consolidate debt without taking out a loan. Credit counseling agencies or a debt management program won’t require you to take out a loan and instead will work with you and the credit card companies to reduce the interest rate. You send a monthly payment to the credit counseling agency and they will distribute the money to each creditor in an agreed-upon amount. This isn’t usually a quick solution.
Avoid These Mistakes with Debt Consolidating
If you are using debt consolidating to save money on loan interest, there are some mistakes you want to avoid.
This will defeat the entire purpose of you using debt consolidating to save money on loan interest. If you have a lot of maxed-out cards or are late on payments then you may not be able to qualify for a lower interest rate. If this is the case, debt consolidating may not be the right choice and you want to spend time improving your credit and paying down current debt as much as possible. Once you have worked on that see if you can qualify at a better rate to start the process.
If you just want lower payments then this is fine but if the goal is to save money on loan interest, a longer repayment period is going to get you in trouble. It means you pay more interest over time. For example, if you could have paid off your debt in two years but it takes you five years to repay the loan then you could be paying a lot more in total interest costs, even if the new loan gives you a lower rate. To maximize your interest savings while consolidating, pick the loan with the shortest possible repayment timeline. When you compare loan repayment terms, don’t just focus on the monthly payment. Look at the big picture, including your total interest expenses, so you know how much the loan is costing you.
If you aren’t using a loan to consolidate debt and instead use a balance transfer credit card, but you don’t pay this on time, you’ll end up paying a lot more. If you don’t pay it off in time then you are owing interest at the card's standard APR, which is pretty high. When you transfer a balance, calculate how much you have to pay per month to get the debt paid off and then makes those payments on schedule. If you take out a personal loan then monthly payments are set in order for you to pay off the loan balance. However, don’t miss a payment so that you pay off the loan in time and it doesn’t hurt your credit.
Consolidating Or Refinancing Student Loans
Student loans are a type of debt where you can refinance or consolidate. When you consolidate your student loans, you are grouping multiple loans into one. You can consolidate to switch from a variable rate to a fixed rate or change the repayment term. Refinancing your student loans will only be available through private lenders. You can refinance to a lower interest rate.
Many borrowers may benefit from consolidating or refinancing student loans. If you are hoping to lower monthly payments then refinance to get a lower rate. If you need help with federal student loans, you can consolidate them into a single monthly payment. If you aren’t sure whether refinancing or consolidating will help you then do some further research and try an online calculator to figure out how to reduce bills.
Tips For Reducing Debt After Refinancing Or Consolidating
After you refinance or consolidate to save money on loan interest, you need to be careful to not run up more debt. Sometimes refinancing or consolidating to save money on loan interest can give you a false sense of financial security and cause you to not be as careful with your budget.
Create a detailed budget that you will be living on while you are consolidating debt. It helps to learn how to lower bills during this time. If you aren’t able to trust yourself that you will not rack up debt again then cut up the credit cards so you don’t use them. Don’t cancel your cards since this will affect your credit score but resist the urge to use any cards. Create a plan to pay off any remaining debt you haven’t consolidated or refinanced.
Cut your spending and get rid of extras that aren’t necessary so you can focus on paying down debt. If you need some extra money then consider picking up a side hustle, such as baby-sitting or walking dogs, to go toward debt payment. In some cases, you will need to make various lifestyle changes to pay down debt, such as relying on public transportation or getting a roommate. Making tough financial decisions could be hard in the short term but have significant benefits later on in life.
Use the money you are saving on the interest and set up an emergency fund. Without an emergency fund, you will end up putting sudden expenses like a car repair or medical bills on a credit card, which can start the debt cycle again. Even if you are keeping up with debt payments, set aside some money each month. While the traditional emergency fund should have three to six months of payments, this can be unrealistic at first. Save as much as you can, especially with the built-in savings from your lower interest rate.
In Conclusion
Refinancing or consolidating can be useful financial strategies to save money on loan interest. No matter what options you choose, be sure to do your research so you aren’t making common mistakes associated with each option. After you refinance or consolidate, make sure that you are utilizing the money that you save on your interest rate and sticking to your budget so you aren’t racking up more debt and getting yourself in a situation to have to deal with either one of these things again.