7 Drawbacks of Refinancing Your Debt

While refinancing can lower your interest rate and make your obligations more manageable, it can also turn into a costly mistake in the long run.

Aug 23, 2014 at 3:00PM

Refinancing is sometimes pitched as if it were a miracle cure for debt woes. But while refinancing can lower your interest rate and make your obligations more manageable, the FDIC recently reminded consumers that refinancing can also turn into a costly mistake in the long run.

Mortgage refinancing is the most widely known form of refinancing, but you can also refinance credit card debt, car loans and even student loan debt. The question is, should you? That answer depends on how the benefits compare with the potential pitfalls.

"Refinancing a personal loan may save you money, especially if you get a lower interest rate, a lower monthly payment or other benefits," said Susan Boenau, chief of the FDIC's Consumer Affairs Section, in the FDIC's written statement. "However, refinancing does not always equate to saving money or better terms."

The downsides of new loans
Here are some of the potential costs noted in the FDIC newsletter and how they can work against your money-saving efforts.

  1. Hidden long-term costs. Sometimes the perceived benefits of refinancing are only temporary. For example, zero percent balance transfer offers on credit cards may temporarily reduce your interest, but since those offers only last a limited time, you need to be careful that you do not end up paying a higher rate in the long run.
  2. Impact on your credit score. Speaking of credit cards, you need to take care in how you manage the opening and closing of accounts. Opening too many new accounts could weaken your credit score, as could closing an old account on which you have established a reliable payment history. If shifting balances around leads you to opening and closing accounts in such a way that it lowers your credit score, then you could end up paying a higher interest rate. That could defeat the purpose of shifting balances around in the first place.
  3. Different interest tiers. Another hazard of balance transfer offers is that those credit cards often charge a different rate for new purchases than for transferred balances. If you make only partial payments toward your balance, the credit card company has discretion over whether to apply that against new purchases or an existing balance, and they are likely to apply your payments against lower-interest debt first.
  4. More years of interest. When it comes to loans, an easy way to lower your monthly payment is to spread the remaining loan balance over more years. Before you do this though, look at an amortization schedule to see the impact a longer loan will have on the total interest you pay. This strategy can prove expensive over time.
  5. Prepayment penalties. Before you refinance any loan, be sure to check the prepayment penalties on your existing loan. They may negate the benefit of lowering your interest rate, but they may be avoidable if you wait a little longer to refinance.
  6. Transfer fees. The catch behind many zero percent balance transfer offers is that there is an upfront fee for making the transfer. Be sure you check for this and factor it into your cost/benefit calculation.
  7. Loss of federal student loan benefits. If you refinance a government-backed student loan with one from a private lender, you may lose certain government benefits, such as income-based payment options.

Remember, financial tactics like refinancing are neither good nor bad -- their value comes down to the numbers. So make sure you have looked at those numbers from every angle before you opt for a new loan.

This article originally appeared on MoneyRates.com.

Your credit card may soon be completely worthless
The plastic in your wallet is about to go the way of the typewriter, the VCR, and the 8-track tape player. When it does, a handful of investors could stand to get very rich. You can join them -- but you must act now. An eye-opening new presentation reveals the full story on why your credit card is about to be worthless -- and highlights one little-known company sitting at the epicenter of an earth-shaking movement that could hand early investors the kind of profits we haven't seen since the dot-com days. Click here to watch this stunning video.


You may also enjoy these articles:
 
 
 

Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Money to your ears - A great FREE investing resource for you

The best way to get your regular dose of market and money insights is our suite of free podcasts ... what we like to think of as “binge-worthy finance.”

Feb 1, 2016 at 5:03PM

Whether we're in the midst of earnings season or riding out the market's lulls, you want to know the best strategies for your money.

And you'll want to go beyond the hype of screaming TV personalities, fear-mongering ads, and "analysis" from people who might have your email address ... but no track record of success.

In short, you want a voice of reason you can count on.

A 2015 Business Insider article titled, "11 websites to bookmark if you want to get rich," rated The Motley Fool as the #1 place online to get smarter about investing.

And one of the easiest, most enjoyable, most valuable ways to get your regular dose of market and money insights is our suite of free podcasts ... what we like to think of as "binge-worthy finance."

Whether you make it part of your daily commute or you save up and listen to a handful of episodes for your 50-mile bike rides or long soaks in a bubble bath (or both!), the podcasts make sense of your money.

And unlike so many who want to make the subjects of personal finance and investing complicated and scary, our podcasts are clear, insightful, and (yes, it's true) fun.

Our free suite of podcasts

Motley Fool Money features a team of our analysts discussing the week's top business and investing stories, interviews, and an inside look at the stocks on our radar. The show is also heard weekly on dozens of radio stations across the country.

The hosts of Motley Fool Answers challenge the conventional wisdom on life's biggest financial issues to reveal what you really need to know to make smart money moves.

David Gardner, co-founder of The Motley Fool, is among the most respected and trusted sources on investing. And he's the host of Rule Breaker Investing, in which he shares his insights into today's most innovative and disruptive companies ... and how to profit from them.

Market Foolery is our daily look at stocks in the news, as well as the top business and investing stories.

And Industry Focus offers a deeper dive into a specific industry and the stories making headlines. Healthcare, technology, energy, consumer goods, and other industries take turns in the spotlight.

They're all informative, entertaining, and eminently listenable. Rule Breaker Investing and Answers are timeless, so it's worth going back to and listening from the very start; the other three are focused more on today's events, so listen to the most recent first.

All are available for free at www.fool.com/podcasts.

If you're looking for a friendly voice ... with great advice on how to make the most of your money ... from a business with a lengthy track record of success ... in clear, compelling language ... I encourage you to give a listen to our free podcasts.

Head to www.fool.com/podcasts, give them a spin, and you can subscribe there (at iTunes, Stitcher, or our other partners) if you want to receive them regularly.

It's money to your ears.

 


Compare Brokers