Should you really refinance?

Refinancing or consolidating your debt in the New Year is often appealing but is it always the best way to get your finances in order?
When you’re considering refinancing an existing loan or credit card debt, it is important to look at a number of aspects. This will ensure that you make genuine savings and don’t wind up paying more over the term of your new loan, or on your new credit card.
Here are five things to consider before you make any switch. 

1. Various fees
Depending on the type of loan or credit card that you are switching to, you may have to pay a fee. In regards to loans, these can include application fees, broker fees or fees for credit reports; for credit cards, it may be an annual fee. Be clear on which fees you’re paying just now and ask for an upfront advice of fees before you get too far down the path of switching. A simple spreadsheet comparison will help to keep things clear. And if the fees are exceptionally high, ask yourself if you’ll benefit financially over the long term once they have been factored into your new agreement. 

2. Interest rates
Interest rates vary between lenders and even a small change of one-eighth to one-quarter of a point can make a significant difference over the life of the loan or on a credit card balance that is not paid off in full each month. Borrowers should also be aware that the longer the loan term, the higher the rate. This is because lenders are taking on a greater risk and is especially true on credit cards. Pay special attention to loans and credit card agreements that have automatic increases, such as adjustable rates, or those that allow lenders to increase rates if payments are made late. 

3. Special promotions
Borrowers should pay special attention to promotions that are offered by lenders. Often, lenders will offer no-cost refinancing of loans, but the rates are higher; or in the case of credit cards, no annual fee for the first year but a higher than average fee thereafter. This can mean that the borrower is still paying the same fees that other lenders charge; they are just paying them over a longer period of time. Carefully review and evaluate all special promotions on loans and credit cards.

4. Credit rating and scoring
Many borrowers do not think about how changing loans or credit cards can have an impact on their credit score. Depending on the changes, the impact can be negative or positive. Loans with a longer term may decrease your credit score, as can having too many credit cards or changing cards regularly. However, loans with a shorter term may increase your credit score. Do not hesitate to ask the lender about the possible ramifications. 

5. Loan terms matter
Loan terms matter when you are changing loans. For example, a borrower who has been paying a 30-year loan for 15 years may not want to refinance to another 30-year loan, regardless of the amount of monthly savings. Over time you will end up paying significantly more. Take some time to review the amortisation schedule to determine which loan term allows you to save the most money, both in the short-term and the long-term. And if you’re on a low or no-interest period on a credit card, be realistic about whether you can actually pay off your balance during this time. The interest rate applied after the promotional rate may cost you more in the long-term.

Useful resources and further reading
Refinancing a loan is a major decision that can have a long-term impact on your finances. Before agreeing to refinance any loan, be sure that you understand the final results. Switching loans may be a great way to reduce your long-term debt and lower your monthly payments, but if you wind up spending more money, the savings may not be as substantial as you thought.

To sum up the whole refinancing issue in a few words it would be ‘don’t jump without looking first’. Research what you’re switching to before you actually file an application. These links will help you to work out what’s the best course of action for you.

Guide to borrowing money – MoneySmart.gov.au
Balance transfer calculator – Finder.com.au
Personal loan comparison – RateCity.com.au 

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Written by Debbie McTaggart

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