Refinancing

What It Means

Refinancing means taking out a new loan to pay off one you already have, so the new loan's rate, term and payment replace the old ones. People refinance mortgagesMortgageA loan used to buy or refinance a home, secured by the home itself and repaid in monthly installments over a set term. See more, car loansCar loanAn installment loan used to buy a vehicle, repaid in monthly payments over a set term, with the vehicle as collateral. See more, student loansStudent loanMoney borrowed to pay for college or career school, repaid with interest after you leave school; it comes from the federal government or a private lender. See more and personal loansPersonal loanAn installment loan, usually unsecured, that a bank, credit union or online lender pays out as a lump sum you can use for almost any personal purpose. See more, most often to get a lower interest rateInterest rateThe yearly percentage a lender charges for borrowing money, not counting fees; the APR adds certain fees to show a fuller cost. See more or a different monthly payment. A refinance usually has its own closing costsClosing costsThe fees and upfront charges you pay to finalize a mortgage, apart from the down payment, itemized on your Loan Estimate and Closing Disclosure. See more or fees, so it saves money only when the lower interest outweighs what the new loan costs to set up.

How People Say It

• "Rates dropped, so we're thinking about refinancing."
• "I refinanced the car and knocked $40 off the payment."
• "Is it worth refinancing if we're moving in two years?"

The Breakdown

Worked example. You owe $25,000 on a car loan at 8% with 48 months left. A lender offers 6%, and refinancing costs $500. Figures rounded to the cent:

What the result means. Keeping the same 48 months, the refinance saves about $23.20 a month, the $500 cost is earned back in about 22 months ($500 ÷ $23.20 a month), and the loan costs $613.48 less overall. Stretch it to 60 months and the payment drops by $127, yet the total cost rises by $203.69, because the balance is outstanding for a year longer. That's the pattern the CFPB describes for car loans: a longer term lowers the payment and adds interest.

The break-even rule. Divide the cost of refinancing by the monthly saving. If you'll sell, move or pay off the loan before that many months pass, the refinance loses money.

Good to Know

Student loans need extra care. The CFPB and studentaid.gov both warn that refinancing federal student loansFederal student loanA student loan made by the U.S. Department of Education, with a fixed rate set by law and federal repayment plans and protections. See more into a private loan ends your access to income-driven repaymentIncome-driven repaymentA federal student loan repayment plan that sets your monthly payment from your income and family size instead of from your balance. See more, deferment, forbearance and federal forgiveness programs, and active-duty service members may lose the 6% rate cap under the Servicemembers Civil Relief Act. On any refinance, compare the fees and the total repaid along with the rate, since the CFPB's refinancing handout notes that a refinance usually comes with closing costs and fees. A cash-out refinance, which borrows more than you owe and pays you the difference, is a different decision with its own page.

Related Terms and Categories

• Cash-out refinance

  Replacing your mortgage with a new, larger one and taking the difference, minus closing costs, in cash.

• Interest rate

  The yearly percentage a lender charges for borrowing money, not counting fees; the APR adds certain fees to show a fuller cost.

• Loan term

  How long you have to repay a loan, usually stated in months for a car loan and in years for a mortgage.

• Closing costs

  The fees and upfront charges you pay to finalize a mortgage, apart from the down payment, itemized on your Loan Estimate and Closing Disclosure.

• Variable interest rate

  An interest rate that can rise or fall over the life of a loan or card because it's tied to an index, such as the prime rate, plus a set margin.

• Private student loan

  A student loan from a bank or other private lender, priced by your credit and governed by its contract rather than federal student loan rules.

Debt and credit