Things no one ever taught me: what it means to refinance a loan
October 18, 2024
Most people have heard the term “refinance,” but how many actually know what it means or how it benefits them? Let's demystify the concept of refinancing a loan and what it means for you and your finances.
What is refinancing?
Simply put, refinancing means replacing your current loan with a new one. It's like trading in your old car for a newer model, but with loans. When you refinance, you're taking out a new loan to pay off your existing one. Why would you do that? The new loan usually comes with different terms or a better rate that saves you money, lowers your monthly payment or helps you pay off that loan faster.
What happens to my original loan?
When you refinance a loan, your original loan doesn't just disappear into thin air. The new loan you're getting pays off the old one in full. It's like using one credit card to pay off another, but in this case, you're hopefully getting a better deal in the process.
Am I selling my car or home?
No. Refinancing doesn't mean you're selling your property to another financial institution. You still own your car or home. The only thing changing hands is the loan itself. You're just switching who you're making payments to and hopefully saving money as a result.
Why refinance?
There are several reasons why refinancing might make sense:
Lower monthly payments: If you can snag a lower interest rate, you could end up with lower monthly payments.
Pay off your loan early: You might choose to refinance to a shorter loan term, which could help you become debt-free sooner. This also saves you money, because fewer monthly payments means you’re paying less in interest.
Both of the above: Sometimes, you can score both lower payments and a shorter term. Win-win!
Other reasons might include switching from a variable to a fixed interest rate, or accessing some of your home's equity through a cash-out refinance.
Are there any downsides?
While refinancing can be great, it’s not without some cost or risk. Here are a few potential cons to keep in mind:
Closing costs: Just like your original loan, refinancing a mortgage or home equity loan comes with closing costs. You can still save money this way, especially if the rate is significantly lower. Just be sure the long-term savings outweigh these upfront costs.
Extended debt: If you're not careful, you might end up extending your debt over a longer period, which could mean paying more in interest over time. However, it could also mean lowering your monthly payments by quite a bit, and that might be worth it to you.
Prepayment penalties: Some loans have penalties for paying them off early. Check if your current loan has any such clauses. AlliedFCU loans DO NOT have these penalties.
Refinancing can be a smart financial move, but it's not one-size-fits-all. If you are thinking about refinancing from another financial institution, you can start by applying to see if you qualify.
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