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How to Get Out of Debt Faster, Part 1

Money Girl’s 5 easy tactics to pay less interest, save more money, and create a more secure financial future.

By
Laura Adams, MBA,
Episode #254

What is a Loan Refinance?

So how do you reduce the interest rate on a loan that you already have? Well, one way is to refinance it.

Refinancing allows you to replace a debt with another debt. You get a brand new loan with a more favorable interest rate and pay off the old loan at the same time. The new loan could come from your existing lender or from a different one.

Loans that are commonly refinanced are mortgages and auto loans. You can pay less if interest rates are lower now than when you originally took out the loan. Additionally, if your credit score is better now, that could also make you eligible for a much lower rate.

However, getting a lower interest rate may not save money if your refinance also stretches out the term of the loan. For instance, if you have 20 years remaining on a 30-year mortgage and you refinance it back to 30 years.

Increasing the length of a loan will decrease your monthly payments, but it typically costs you more interest over the life of the loan. Plus, a longer term doesn’t help you pay off the balance any faster, which is what I’m focusing on here.

Therefore, to save the most money and pay your debt off as quickly as possible, refinance it for a lower interest rate using the existing payoff schedule, or a shorter one.

There are fees involved in doing a refinance as well as equity requirements for home loans, so speak to your current lender and shop around to find the best deal.

There are many online calculators at sites like mortgagecalculator.org, dinkytown.com, and bankrate.com to help you crunch the numbers and take a closer look at whether refinancing makes sense for your situation.

But what if you can’t refinance a mortgage because you’re underwater and owe more than your home is worth? A loan modification might be the solution.

What is a Loan Modification?

A loan modification is typically an option when you demonstrate that you have a long-term hardship or inability to repay a mortgage. It’s similar to a refinance, but with no fees.

A loan modification may reduce your interest rate, extend the length of the loan, or change the type of loan (from an interest-only to a fixed-rate product, for instance), or a combination of these solutions. In general, a lender would rather keep you as a paying customer with a modified loan than to foreclose on a property if you default.

Starting in May 2012, the federal government is rolling out a new and improved Home Affordable Modification Program (HAMP) to help more people. If you’re employed but struggling to pay your mortgage, this program can reduce your monthly payment to 31% of your gross or pre-tax income—even if you’re underwater.

Lenders will have all the details about the expanded program in February 2012, so be sure to contact them to discuss your options. You can also visit makinghomeaffordable.gov for more information.

What is a Loan Consolidation?

What if you have multiple debts—like student loans or credit cards—that are weighing you down?

Refinancing multiple debts into one is called a loan consolidation. Not only can consolidation save you money when the interest rate is reduced, but it makes managing the debt easier because you only have one payment each month.

Private and federal student loans can’t be combined, so they must be consolidated separately. Also note that any special repayment options included in your original student loan may be canceled if you consolidate it.

To learn more about your options for federal student loans visit loanconsolidation.ed.gov. If you have private student loans, contact your lenders for refinancing and consolidation options.

If you have debt on several high-interest credit cards, save money by consolidating them with a low-interest personal loan that you take out from an online lender or a local credit union. Any time you can substitute high-interest debt for lower-interest debt, you’ll save money that can be used to pay down the principal debt balance faster.

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