Should You Consider Refinancing Your Debt?

May 15, 2018 12:59 pm

Kristina M. Mello, MBA

Financial Planner and Compliance Associate

As we are now experiencing a rising interest rate environment, it is imperative to take a close look at your debt obligations to determine if action should be taken. Many of us have enjoyed low interest rates on our debt for several years now, and this may have swayed your decision to accept variable rate terms in order to significantly reduce monthly payments. Now that things are changing, however, it is important to evaluate if your current debt situation is still optimal.

Variable Rate Loans
As little as two years ago variable rate loan options were a no brainer for some. The amount of money you could save each month by having your note tied to an index, such as LIBOR, was substantial due to LIBOR’s historically low rates. Not only were rates low, but they remained low for quite some time, and we got comfortable. Now rates have begun to rise, and will most likely go higher before coming back down. In the months and years to come, this can raise your monthly payments considerably. In one month’s time, your payment can go from being affordable to not sustainable, making it possible to default on your loan. Don’t let yourself be caught by surprise in a situation that could have serious repercussions on your credit score and excellent payment history. Start shopping lenders for options and fix your variable rate debt sooner rather than later.

Interest Only Loans
Interest only loans are very attractive due to their minimal monthly payment obligation. However, these loans are often not meant to be a long-term strategy. Frequently referred to as “non-amortizing” loans, IO loans require payments only to cover the interest costs. Payments applied to your principal are voluntary. This means eventually you could be expected to make a balloon payment, resulting in an enormous expense. For this reason, it is typically advised that the loan be refinanced, or the property sold, before the loan comes due.

As rates rise, your monthly payment increases in tandem with the underlying index the loan is linked to. . This applies to fixed rate loans as well as variable. Therefore if you plan to hold your loan for a few more years, it would be prudent to explore your options now.

Student Loans
Student loans affect millions of Americans, and often for many years to come after graduating college. They can be very burdensome on your overall financial picture and may limit your ability to be qualified for certain large purchases that require financing, such as buying a home, Considering the impact they have on so many people, it may seem surprising that many are not in the best loan product for them, mostly because they are unaware of their options or don’t understand the implications of refinancing. If you are dealing with student loan debt, consider a few factors to determine if refinancing is best for you.

First, do you have more than one loan with different lenders at different rates? Be sure to evaluate each loan term and rate to see how they impact your monthly cash flow and overall interest paid on the life of the loan. Refinancing can help reduce both, as well as help to simplify and organize your debt.  Another big factor to consider is whether your loans are federal, private, or a combination of both. There are certain perks that come with having federal loans that you will relinquish if you refinance everything to a private loan, and traditionally private loans are not allowed to be consolidated with federal loans, but federal loans can be consolidated into a private loan. This doesn’t necessarily mean it is a bad choice, however. You just want to make sure you have thought through the decision and evaluated what best suits your life.

For example, federal loans usually offer income-based repayment options, as well as some debt forgiveness for those who work in public service. Furthermore, federal loans are often considered to be cheaper than private loans, but this differs among providers and therefore should be evaluated. If you do not qualify for any of the perks offered by having a federal loan and you can consolidate your loans to a private loan with a lower rate, this may be in your best interest.

Another factor to consider is whether your loans are fixed or variable. As discussed above, it is imperative that you have control over your monthly payment in this changing interest rate environment, and that most likely means refinancing to a fixed rate loan.

Credit Cards
As an unsecured line of credit, credit card companies are willing to take on the risk of default by charging high interest rates.  Even in the low interest rate environment we have been experiencing, it is still common to see average credit card rates in the teens. If you have been making on time payments and have decent credit, you have probably received offers for zero percent interest on balance transfers for a period of time. Taking advantage of this offer can really make an impact on your financial life. If you do a zero percent balance transfer and adhere to a budget, you can really clean up some credit card debt quickly, allowing you to spend your money on other things. If you are tight on monthly cash flow but stick to making the same payment you had been making, you will still pay down the debt faster than you would have with the original staggering interest rates. You can also use this method to consolidate multiple credit cards to one, credit line permitting.

Debt can be overwhelming, but it is important to manage this side of your balance sheet. If you take the time to look at your options and become proactive, you could help pay it down in a more prudent manner.

 

Kristina Mello, MBA serves as Financial Planner and Compliance Associate at StrategicPoint Investment Advisors in Providence and East Greenwich. You can e-mail her at kmello@strategicpoint.com.

The information contained in this post is not intended as investment, tax or legal advice. StrategicPoint Investment Advisors assumes no responsibility for any action or inaction resulting from the contents herein. Kristina’s opinions and comments expressed on this site are her own and may not accurately reflect those of the firm. Third party content does not reflect the view of the firm and is not reviewed for completeness or accuracy. It is provided for ease of reference.