Factors to consider before refinancing a loan, according to experts

The Federal Reserve announced a half percentage point, or 50 basis point, rate cut at the end of its two-day meeting on Wednesday. And, of course, some Americans will want to make the most of the central bank’s first rate cut since the early days of the Covid pandemic.

“How quickly the impact of lower interest rates is felt depends on whether households have variable or fixed interest rates,” said Stephen Foerster, professor of economics at the Ivey Business School in London, Ontario. Some adjust quite quickly, others don’t reset at all.

That is, unless you can refinance.

According to a recent report by NerdWallet18% of consumers said they planned to refinance a loan once interest rates drop. The financial services website polled more than 2,000 US adults in July.

While taking advantage of lower interest rates could make financial sense, there are often other considerations, depending on the type of loan, experts say.

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For starters, while mortgage rates are partly influenced by Fed policy, they are also tied to Treasury yields and the economy. Thus, mortgage rates may continue to fluctuate.

In addition, most homeowners still have a lower interest rate on their loan than they would likely get if they refinanced now — with the exception of those who bought a home in the last two or three years, according to Jacob Channel, senior financial analyst. on LendingTree.

Roughly 82% of homeowners are locked in below 5%and 62% have rates below 4%, a 2023 Redfin analysis found.

“There’s no universal rule for when people should consider refinancing a mortgage,” Channel said. “Some people will tell you that you shouldn’t consider refinancing until you can get a rate that is at least 50 basis points lower than what you currently have, others will say that you should wait until you can get a rate of 100 or more basis points lower’.

Other factors to consider are your credit rating, which will ultimately determine the interest rate you can qualify for, and closing costs, which are typically 2% to 6% of your loan amount for refinancing, according to LendingTree.

“There is no single answer to the question of whether or not someone should refinance their mortgage,” Channel said.

When it comes to credit card debt, the math is a little trickier.

Since most credit cards have a variable interest rate, there is a direct link to the Fed’s benchmark. In the wake of the rate hike cycle, the average credit card interest rate has risen from 16.34% in March 2022 to more than 20% today — approaching an all-time high. Those APRs will be lower now, but not significantly.

Regardless of what the Fed does, refinancing high-interest credit card debt is a good move, according to Matt Schulz, chief credit analyst at LendingTree.

“A 0% balance transfer card is probably your best option, assuming you have good enough credit to get one,” he said. “A low-interest personal loan can also be a good tool.”

Alternatively, borrowers can call their card issuer and ask for a lower interest rate on their current card. The average decrease is about 6 percentage points, according to LendingTree research. “That’s like going from 25% to 19%, and it’s much more impactful than anything the Fed is going to do,” Schulz said.

Although auto loans are steady, interest rates on new car loans will fall with the Fed’s moves.

But for those with existing auto loan debt, refinancing isn’t a given.

“The interest on a car loan is weighted more toward the beginning of the loan; so if you’ve had the loan for a year or two, you’ve already paid enough interest,” said Ivan Drury, director of Edmunds. information. “Although lowering your interest rate lowers your monthly payment, it could result in you paying more interest over the life of the loan.”

Plus, “if you were paying mostly interest, you might not have enough equity — or any equity — to really take advantage of the lower interest rates,” he said, unless you put more cash into the refinance and take out a smaller loan.

Consumers may benefit more from improving their credit scores, which could pave the way for significantly better loan terms, he said.

Finally, student loan borrowers with private variable rate loans may have reason to consider refinancing as interest rates fall.

“Borrowers can choose to refinance their loans to take advantage of lower interest rates or improvements in their credit scores, which can also lead to lower interest rates, or if they want to switch lenders,” said higher education expert Mark Kantrowitz.

However, refinancing a federal loan into a private student loan will waive the safety nets that come with federal loans, such as deferments, forbearances, income-based repayment and loan forgiveness and discharge options, according to Kantrowitz.

And like other types of refinancing opportunities, extending the term of the loan means you’ll end up paying more interest on the balance.

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