For many people, refinancing is a financial strategy used to reduce interest rates by lowering their monthly payment, and perhaps helping you access some of the equity in your home. But it has questions and can mean changes to your loan terms. One key question borrowers frequently ask is: Is refinancing the mere extension of your loan? In this article we take a look at what refinancing is, how it affects loan duration and the ways in which it can change the way that you think about your finances.
What Is Refinancing?
Refinancing involves replacing your existing loan with a new, different loan. This is the usual way you get a mortgage, auto loan and student loan. Borrowers refinance simply to take advantage of better interest rates, extend out repayment terms, or change loan type (for example, from an adjustable rate product to a fixed rate product).
The Effect Of Refinancing On The Loan Duration
Refinancing can add or shorten that term. Let’s explore how this works:
1. Extending Your Loan Term
With a refinance, you can reset the clock on your loan. Take, for instance, if you have 10-years left with a 15-year mortgage and refinance into a new 15 year loan, your payment timeline resets.
Pros of Extending Your Loan Term:
Lower Monthly Payments: The debt is spread out over longer period meaning less money will come out of your bank account each month.
Eases Financial Strain: Helpful for all borrowers in a situation of financial difficulties and who require an instant relief.
Cons of Extending Your Loan Term:
Higher Total Interest Costs: If the interest rate is lower, the second effect is to prolong the loan: and that means paying more interest, the more time that goes by.
Delayed Debt Freedom: You have to pay longer to fully pay off of your loan.
2. Shortening Your Loan Term
Refinancing doesn’t always give you a longer loan term. Other borrowers refinance into shorter terms, such as a 30-year mortgage to a 15 year mortgage.
Pros of Shortening Your Loan Term:
Reduced Interest Costs: Generally speaking, shorter terms work with lower interest rates, lower total interest cost.
Faster Debt Payoff: By becoming debt free quicker it can be a major financial reliever.
Cons of Shortening Your Loan Term:
Higher Monthly Payments: A shorter repayment period means you’ll end up paying more each month, potentially putting your budget strain.
Before refinancing, there are some things to consider
Refinancing is based on so many factors including your financial goals, current loan terms and individual circumstances.
1. Current Interest Rates
Refinancing works when you’ve got a lower interest rate than what you’re paying now. We can even save a small reduction over time.
2. Remaining Term and Loan Balance
If you’re already halfway through your loan though, an extended term may not be the most economical since the interest costs will rise.
3. Closing Costs
Closing costs for refinancing usually run from 2 to 5% of the loan amount. In deciding to refinance, factor these costs into the decision to answer the big question: is refinancing worth it financially?
4. Break-Even Point
Find your break even point — the time it takes for your refinancing savings to pay for closings. If you’re going to sell the property or pay off the loan before you get there, refinancing might not make sense.
When Refinancing Extends Your Loan: Key Scenarios
Here are some common scenarios where refinancing extends the loan term:
Switching to Lower Monthly Payments: Longer loan terms are usually taken by borrowers who aim at paying monthly payments.
Adjusting to Financial Challenges: Paying a monthly payment that would force you to locate every dollar you could barter or borrow from family and friends, after you lose a job and medical expenses and other financial setbacks prevent you from making the payment, is not a smart idea.
Accessing Equity: With a cash-out refinance you can use the accumulated equity in your home to increase the loan amount, as well as the term.
Minimizing Loan Extension Effects
If extending your loan term is unavoidable, you can still minimize its impact:
Make Extra Payments: The more you pay beyond the minimum monthly amount, the faster your principal is paid off, and the shorter is the effective term.
Refinance Strategically: Pick a term that has lower payments and manageable overall costs.
Monitor Interest Rates: Refinance only when it pays to extend the term of the loan by lowering the rate enough.
Refinancing: A Double-Edged Sword
The benefits with refinancing can be really powerful but it is imperative to weigh the pros and cons thoroughly. The downside is that it may lengthen your loan, but the savings in lower interest rates or monthly payments may more than offset the downside in the longer term.
Conclusion
Does refinancing help extend your loan? It will really depend on the new loan terms you decide to have. No matter whether your refinancing stretches or decreases the length of your loan term, you should find that this decision is in line with your financial objectives and situation. Get a feel for the process, make a dollar cost compare, and talk to a financial advisor before you proceed.
After all, the details of refinancing don’t have to be one of the anxiety inducing topics of your life.
