FDIC Consumer News
Spring 2014
Refinancing Loans: Not Just for Mortgages
Most people know they can refinance a mortgage - that is, replace an existing loan with a new one that may offer better terms. But did you know you also can refinance personal loans, including auto loans, credit cards and student loans?
"Refinancing a personal loan may save you money, especially if you get a lower interest rate, a lower monthly payment or other benefits," noted Susan Boenau, Chief of the FDIC's Consumer Affairs Section. "However, refinancing does not always equate to saving money or better terms."
Here are ways to see if refinancing makes sense for you.
Think about your goals. For example, if you want to simplify your life by consolidating multiple credit card accounts, most card lenders allow you to transfer balances from other accounts for a fee. "Once you determine what you want to accomplish, you can make a better decision about whether refinancing is right for you," Boenau added.
Understand potential pitfalls. While you may be able to take advantage of promotional offers, such as introductory zero-percent interest or low Annual Percentage Rates (APRs), by transferring a balance and closing a credit card account, you also may have a higher APR than what you were originally paying when the promotional rate ends.
Closing a credit card account also reduces your available credit and may adversely affect your credit score, which lenders often use to determine your interest rate. To avoid a reduction in your credit score, consider keeping cards you have managed well for a long time.
A balance transfer also may result in your account having multiple interest rates (such as one for your "purchase balance" and one for your "transfer balance"), so know how your payments will be classified. For instance, if you only pay the minimum required each month, a creditor can generally apply that payment any way it chooses. This includes applying your minimum payment to lower-rate balances first, which means higher-rate balances will keep accruing higher interest costs. Depending on the circumstances, a large balance transfer also may trigger fees for going over your credit limit until you can bring the balance down.
Other examples include the following:
- You may be assessed a prepayment penalty if you refinance a loan before it matures.
- If you trade in a car loan for a new one with a longer repayment period, perhaps for five or more years, you may get lower monthly payments but you might not save money in the long run. "You'll likely end up paying more in total interest, plus your car's resale value may fall below what you owe on the loan," noted Frances Tam, an FDIC Senior Consumer Affairs Specialist. "Then when you want to sell or trade in your car, you may have to put in additional money to pay off the loan."
- While multiple federal student loans may be consolidated (combined into one loan with a single monthly payment), individual federal loans generally can only be refinanced (paid off and replaced with a new loan) through a private lender, and that could result in the loss of important federal benefits. "Understand the benefits you may be giving up, such as loan forgiveness for entering public service and income-based repayment options, before refinancing a federal student loan," warned Heather St. Germain, an FDIC Senior Consumer Affairs Specialist.
If your credit score is low, consider waiting to refinance until you can raise it. You can protect yourself by ordering a free copy of your credit report from each of the three major credit bureaus (visit www.AnnualCreditReport.com or call toll-free 1-877-322-8228) and correcting inaccurate information.
Also remember that, for purposes of improving your credit score, the most important things are to be financially responsible and to correct any errors in your credit reports.
For more tips on improving your credit report and score, see Your Credit Reports and Credit Scores: Simple Steps to Make Them Better.