I talked about how to manage credit cards loans and lines of credit the other day. I wanted to dig into one of the topics I discussed in more depth. You can listen to the podcast below
https://anchor.fm/letstalkaboutitfinance/episodes/Lets-Talk-About-Debt–Credit-Cards–Lines-of-Credit–and-Loans-e1jgat0Refinances can take many different shapes and forms, it’s essentially the process of paying off one or more credit products, with another credit product.
Why would you refinance?
If you can save money on your interest payments, then refinancing often makes sense. In the case of a mortgage refinance there’s some other fees associated that need to be included, but if you can pay your debt off in a similar amount of time, or less, and pay less in interest and fees that’s almost always going to be a win.
How do you decide if it’s a good deal then. This is mostly a question of math. As a good rule of thumb, lower interest rates are better, but if you want to determine things more precisely you can build a table similar to the one below.
| Credit Product | Amount Owing | Interest Rate | Payment (Monthly) | Remaining Time (months) | Interest Cost |
|---|---|---|---|---|---|
| Credit Card | $8000.00 | 21.99% | $240.00 | 52 | $4,473.04 |
| Line of Credit | $15,000.00 | 8.95% | $450.00 | 39 | $2,309.96 |
| Loan | $5,600.00 | 4.95% | $245.28 | 24 | $286.76 |
Lines of credit and credit cards don’t have a fixed minimum payment, so to do this math you assume it’s a loan, and starting with a 3% payment that we don’t decrease we can make something that’s comparable to a loan.
When you’re looking at your own situation most of these numbers are going to be available to you from your statements, but putting them together make it easier to make decisions.
If a refinance loan is just a loan it only makes sense to pay off your debt if it reduced your cost. Depending on your financial situation a lender might require you pay out all of your debt which might include debt with a lower interest rate. It’s important to make sure that your overall interest rates are lower.
If you have the option to pick and choose what you pay off. Based on the above example, wouldn’t pay out the loan unless the interest rate available was under 4.95%. If the rate is lower then 8.95% then you’re going to save money on the credit card and line of credit.
I’ve been focusing on the cost of interest here, because you can reduce your monthly payments without reducing your interest costs, by taking longer to pay your debt back. You can refinance your debt, and actually increase the cost of your debt by taking on a longer amortization at a higher interest rate. So you need to be careful with a refinance, the goal is to pay less, not more.
One of the most important elements to managing your debt is to understand your options, and keep on top of things so you do the best for yourself.