Lisa Whitley — From the “Silver Linings” file cabinet, you have undoubtedly noticed that as the economy takes a downward turn, interest rates have followed. For savers, this is not good news but if you have outstanding debt, steady income and a strong credit score, this may be a very opportune time to consider if you can reduce the cost of what you owe and pay it off faster. Much of the attention has been focused on mortgage rates. But have you considered all of the possibilities?
If you carry a balance on your credit card, you may be paying an interest rate above 20%. There are a couple of popular ways to refinance this debt: transferring the balance to a new zero-interest rate credit card or taking out a fixed unsecured loan and using the proceeds to pay off the credit card. But don’t jump just yet! The question you want to ask yourself first is this: “What was my plan for paying off this credit card balance before I heard about this low or no interest opportunity?” If you did not have a plan in place — and particularly if the balance on the credit card is growing because you are still using credit — then transferring the balance to another credit card or to a personal loan is likely to increase your debt. What happens far too often is that a person will transfer the old debt to the new card or personal loan, and then continue spending on the old card. And the new card too! Before you even think about refinancing your credit card balance, you need to address the fundamental issues that have led you to build up this debt. (Yes, I am talking about a budget.)
Private student loans may also be ripe for refinancing at this time. (You cannot refinance a federal student loan to a lower interest rate with a new federal loan. And if you refinance a federal student loan with a private loan, you lose all of the protections of the federal student loan program.) For borrowers with the highest credit scores (generally at least 720), rates below 4% may be possible. The amount of savings here could be phenomenal: over 10 years, a reduction from 7% to 4% for a $50,000 balance would result in interest savings of almost $9,000.
And don’t forget your auto loan. If your vehicle loan is “in the black” — that is, the amount of your outstanding loan is less than the value of the car — you may be able to benefit from refinancing your auto loan. For the best rates, your vehicle will probably need to be not more than a few model years old and these rates are very sensitive to creditworthiness. But if you are able to reduce your rate from 8% (the average in 2019) to today’s 5%, that will save more than $1200 over four years for a $19,000 loan.
And now, mortgages. This is probably the most complicated refinancing process you will ever encounter. But because the potential savings are so high, it may be worth the considerable effort as many have discovered. Mortgage refinancing activity has surged this year with the fall in interest rates. Here are the basics to consider:
- What is my current interest rate versus the market rate today? In general, if your current interest rate is not at least .75 percent to one full percentage point higher than the rate that you would refinance to, then it will not be economical to refinance, because…
- Closing costs are considerable. Refinancing your mortgage is not considerably different than when you took out the loan at the beginning. You can expect closing costs in the range of 2% to 6% of the loan amount. How will you pay it? Yes, you may be able to roll these costs into the new loan, but of course this has the effect of reducing your savings…which is why you started down this path in the first place.
- Your income, credit score and the value of the home still matter. Again, just as was the case when you first took out your mortgage, lenders will scrutinize your finances and the home you are “purchasing” in the same way…
- Which means that even during this time of social distancing, your lender will probably still require a home appraisal.
There are numerous mortgage refinancing calculators available online where you can plug in your numbers and get an estimate of whether or not refinancing makes sense for you. Just know that as refinancing activity continues to surge, your lender may be overwhelmed so be prepared for the process to take longer than usual.
No one would have wished for the current crisis. But nevertheless, for some this does create an opportunity to shore up their financial foundations by reducing the cost of outstanding debt. These are savings that can be redirected to other, more productive goals — increasing retirement savings or bolstering a liquid savings cushion. If you are fortunate to find yourself in this position, then now is the time to act.
Lisa is an Accredited Financial Counselor (AFC) leveraging her professional and educational experience in finance and economics. Lisa’s 18-year career in international development has given her the opportunity to appreciate the value of diverse societies, and to work across cultures to improve lives. As an AFC, she plans to continue that perspective, working with all households to achieve financial wellness.