Refinancing is a debt management process where a lender buys out an existing debt, such as a mortgage or car loan, in exchange for a new loan. The new loan you receive as a result of refinancing can have a different interest rate, duration and specifics. Refinancing can potentially result in lower monthly loan payments, but there are also several negative aspects to refinancing.
Interest Owed
One of the primary reasons to refinance a loan is to reduce the amount of interest owed. If interest rates have fallen recently, it may be possible to refinance a loan to a lower rate. If you extend the life of your loan as a result of refinancing, however, it may increase the overall amount of interest you pay, since you are paying interest for a longer period of time. Also, if you switch your interest rate from a fixed rate to a variable rate, the amount of interest you pay could increase over time as a result of refinancing.
Refinancing Costs
Another drawback to refinancing a loan is that the refinancing process often involves various fees amounting to several percent of the total value of the loan. Since mortgages often exceed $100,000, refinancing fees can easily add up to several thousand dollars. The cost of refinancing can negate the savings gained from lower interest rates. The costs and benefits of refinancing should be considered carefully to make sure applicable costs do not exceed savings.
Credit Impact
Refinancing a loan can potentially have a short term negative impact on your credit rating. According to Lending Tree, when you refinance a loan, "your credit score will take a temporary hit as it does when you get any loan." The credit impact is reduced as you make payments on the new loan, but if you seek new credit or loans soon after refinancing, it could potentially lead to paying more in interest.
Considerations
The best time to refinance is after a period of falling interest rates. Switching from a variable interest rate to a fixed rate can allow you to lock in at a low interest rate and avoid potential rate increases in the future. It is possible to refinance a loan more than once, but this will cause you to incur refinancing costs multiple times.
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