Y our financial decisions have a huge impact on your ability to make payments on debt and invest for the future. If you have a large amount of debt outstanding, your financial decisions are even more critical. Every borrower needs to understand the difference between refinancing and consolidating debts.
Your financial goals
Many consumers use either refinancing and loan consolidations to lower their monthly payments on debt. If loan payments represent a large percentage of your total income, reducing monthly payments can have a big impact on your finances. For example, you can set up an emergency fund with the money you save on your loan payments. The extra monthly income can help you achieve your financial goals.
Refinancing means that the borrower’s loan repayment schedule changes. When you take out a home loan, for example, you make monthly payments based on a payment schedule. Assume that Bill takes out a $100,000 25-year home loan to purchase his first house. The interest rate is 4.5% and his monthly payment is $555.83.
After making his monthly payments for five years, Bill decides to look into refinancing his loan. He notices that interest rates have declined, and that lenders are encouraging borrowers to refinance debt. His 4.5%, 20-year loan is paid off and replaced with a 3.0%, 25-year loan. While Bill is adding 5 years to the life of his loan, the lower interest rates allow him to reduce his monthly payment.
Your decisions about debt repayment have a big impact of your finances, so do your homework first!
Some borrowers combine their debts into one large (consolidation) loan, and that new loan has a lower total monthly payment. In order to qualify for his home loan, Bill wants to lower his monthly payments on student loans. Currently, Bill has $50,000 in student loan debt outstanding with three different lenders. He must make payments for another 10 years at an average interest rate of 6%, and his monthly payment is $555.10.
Bill finds a lender that can combine his three loans into one larger loan at a 4% interest rate. This consolidation loan requires payments for 15 years and the monthly payments total $369.84. The loan consolidation lowers Bill’s monthly payments by $186.
Consider your income
If you refinance debt or consolidate loans, you will make monthly payments over a longer period of time. Keep in mind that you may increase your income over time, and that makes it easier to pay down your debts. In fact, you may choose to repay debt at a faster rate, so that you pay even less interest over time. Check out our Be Your Own Boss page to learn how you can easily earn an extra $1,000 per month in your spare time and get your loans paid down even faster!
Do your homework
Your decisions about debt repayment have a big impact of your finances, so do your homework. Make sure that you clearly understand the terms of any loan agreement, including the interest rate, monthly payment amount and the number of years the loan is outstanding. Use these tips to make informed decisions about debt and be sure to check out our Refinancing & Consolidation Page to see how much you could be saving.