How Refinancing Can Save your Financial Health

Say you have the following accounts:

• A 30-year fixed mortgage with what was once considered a good interest rate
• A 60-month auto loan at a moderate interest rate
• $10,000 in credit card debt – the average amount carried by the American consumer – at an astronomical interest rate
• Student loans with a very low interest rate

Now let’s say you’ve got at least $50,000 in equity in your home. With today’s record low interest rates on home loans, it makes sense to refinance, consolidating all your higher interest rates into a single loan. Right?

Not so fast.

Pros to Debt Consolidation

Sure, there are plenty of benefits to consolidating your loans through a low-interest refinance. The single biggest pro are today’s mortgage rates. While interest rates on new vehicles are also close to historical lows – just over five percent for a 60-month loan on a new vehicle – they still can’t hold a candle to the sub-four percent interest rates currently available on 30-year fixed home loans.

Another major factor in your favor? The opportunity to put extra cash in your pocket right now. Consolidating these loans into a 30-year fixed at a rate of four percent can slash hundreds off your monthly payments. A loan calculator – like the one I use online – may even tell you your “break even” point is just a few short years. Sounds like a no brainer, unless…

Cons to Debt Consolidation

While reducing your monthly payments through debt consolidation can help your finances in the short run, in the long run they’re not always worth it. First, take into account the cost of loan origination – with points, you could be looking at $10,000 to $20,000. A second major drawback? The length of your loan. Extending a relatively short loan – like a 60-month auto loan – to a 30-year term will have you paying thousands of additional dollars in interest over the life of the loan.

The Bottom Line

It all comes down to which loans you want to. Consolidating high-interest, long-term loans – like a home equity loan, or a second mortgage on a vacation property – are sure bets. Wrapping short-term loans – even those with high interest rates – may cost you in the long run.

Then there’s the matter of what you’ll do with your extra monthly savings. If you plan to use some of that money to pay down your principal, you could reduce your payoff time by months, years, or even a decade or more, potentially saving you tens of thousands – even hundreds of thousands – of dollars in interest.