As of late, The Federal Reserve has continued to keep its benchmark interest rate near zero. Although the benchmark interest rate is not the rate that average consumers pay, this rate (called the federal funds rate) affects the borrowing and savings rates on other loans and debt throughout the economy. These historically low borrowing rates can benefit individuals by making loans cheaper; whether it be student loans, mortgages, or credit card debt. For people with current loans, one way they can take advantage of this environment is to consider refinancing existing debt. Debt refinancing is the replacement of an existing debt by means of another debt with terms and/or conditions that are more favorable. Some of the more common reasons to refinance debt include taking advantage of a lower interest rate, reducing monthly payments by extending the length of a loan, or altering certain terms of the loan like whether the debt is fixed-rate or variable-rate.
Mortgage
Let’s start with an example that many Americans are familiar with: Mortgage loans. The interest rate on a mortgage is determined by both current market rates as well as the level of risk the lender takes to lend you money. This interest rate on a home buyer’s loan can have a significant influence on the monthly payments they will be required to make. Here is an example: Let’s say someone is looking to buy a $250,000 house in my hometown area of Southington, CT. This individual wants to make a down payment of 20% and is considering a 30-year fixed-rate loan. In November of 2018, the average mortgage rate on this type of loan was 4.87%.1 In this scenario, the estimated monthly payment would be about $1,058; excluding taxes and insurance. In June of this year, the average mortgage rate on this type of loan was 2.98%.1 In this scenario, the estimated monthly payment would be about $841; also excluding taxes and insurance. That is a difference of over $215 dollars each month! Annually, this translates into a difference of over $2,500 dollars!
Student Loans
Home owners aren’t the only ones that may benefit from refinancing their loans. Student loans have been a widely discussed topic in the news over the past few years. Since March 27, 2020, federal student loan interest rates have been set to 0% and payments have been paused. The circumstances and timing of resuming these payments is being discussed throughout the United States government. With that being said, many borrowers have private student loans that don’t always qualify for forgiveness or forbearance. For these borrowers, it is common for them to consider refinancing their private student loans to achieve more favorable terms. Some of the Pros of refinancing student loans include the potential to lower the interest rate as well the potential to lower the monthly payment. In addition, there are usually no application, origination, or prepayment penalty fees. The disadvantage to refinancing private student debt: you’ll likely need a high credit score to qualify for a rate that makes refinancing worthwhile. There are a number of online calculators available that can help you evaluate if you should refinance your private student loans including this one from Credible: Student Loan Refinance Calculator: Should I Refinance? | Credible .
Credit Cards
Many of us are all too familiar with credit card debt. According to the consumer debt data report from the Federal Reserve Bank of New York, Americans’ credit card balances totaled $770 billion as of the first quarter of 2021.2 Another Federal Reserve consumer credit report showed that the average APR (annual percentage rate) for all current credit card accounts was 14.61% in the second quarter of 2021.3 Since the majority of credit cards are unsecured loans, the interest rate applied to credit card debt tends to be significantly higher than on loans with collateral like mortgages or car loans. Still, there are strategies available, like credit card debt consolidation, that can reduce interest costs or shorten the payoff period. Consolidating your credit card debt may be a good idea for someone if the new debt has a lower APR than your current credit cards. Refinancing with a balance transfer credit card, consolidating with a personal loan, or utilizing home equity are all examples of effective ways to reduce credit card debt for certain borrowers.
There are many things to consider when evaluating if you should refinance any outstanding loans you may have. Some of these factors include: your credit score, your current debt-to-income ratio, and any fees/costs associated with the new loan, to name a few. As always, it is important to analyze the specifics of your situation before making any decisions related to refinancing. But for many, this low interest rate environment offers a great opportunity to potentially lower the overall cost of outstanding loans.
1. http://www.freddiemac.com/pmms/pmms30.html
2. https://www.newyorkfed.org/microeconomics/hhdc
3. https://www.federalreserve.gov/releases/g19/current/