You’ve probably seen it in the news: over the last two years, US consumers have been flocking to renegotiate their mortgages and refinance student loans as interest rates fell.
So, what’s refinancing? When you refinance (or refi), a lender pays off your existing loan(s), replacing them with a new loan with a lower interest rate. Interest rates fluctuate in cycles over time; when Federal Reserve policy and market conditions are right, lending increases as interest rates drop. We call this cyclical phase of low interest rates a refinancing economy, since the falling interest rates make this an ideal time for many borrowers to refinance their loans.
Let’s go over refinancing: its recent history, its pros and cons, and whether refinancing is the right move for you.
Interest rates are rising
The years 2020-2022 saw a historic boom in mortgage refinances, but all this is cyclical; interest rates are once again rising and refinance volume is dropping. As credit becomes more expensive, many borrowers face a closing window to refinance the terms of their loans before interest rates become less favorable. That raises the question: are we still in a refinancing economy? In short, no—but that doesn’t mean refinancing can’t be right for you.
More than just mortgages
A lot of discussion around refinancing centers on mortgages. However, you can renegotiate just about any debt. Many people take the opportunity to refinance their business, personal, car or student loans, lowering their interest rates or switching from variable to fixed-rate loans (or vice-versa). Some student loan providers will even lower your refinance rate if you open a checking account with them while refinancing.
If you have federal student loans, however, take note: refinancing precludes any protections federal student loans offer, such as income-driven repayment programs, and makes you ineligible for loan forgiveness programs like Public Service Loan Forgiveness or Teacher Loan Forgiveness.
With interest rates rising, now might be your best opportunity to switch from a variable-rate to a fixed-interest loan. Be aware that refinancing isn’t always going to be the best choice, though, particularly if a longer payment period leads to you paying more interest over the lifetime of your loan. It’s important to calculate whether the new rates and payment terms make refinancing your loan a good idea.
As you consider your choices, take note of the different options available to refinance debt:
- Rate-and-term refinancing: The most common form of refinancing, where your original loan is paid off with a new loan with lower interest rates.
- Consolidation refinancing: Do you have many loans with high average interest rates? Through consolidation refinancing, a lender could pay them off, leaving you with a single loan with a lower interest rate.
- Cash-in refinancing allows you to pay down some portion of your loan in return for lower monthly payments.
- Cash-out refinancing allows you to take out additional debt to account for your collateral—say, your house—appreciating in value.
Is refinancing right for you?
We already know the latest refinancing boom has come and gone. Given the prevailing economic conditions, is a refinance right for you? Yes—provided you renegotiate your debt to more favorable terms. It’s vital you make sure your new loan won’t cost you more in the long run; as always, it’s best to shop around and crunch the numbers to determine whether refinancing your debt is the right choice for you.