Paying off a loan is a good feeling. No more monthly payments to manage, no more interest accruing. But in some cases, you might be better off refinancing to save money on debt with a high-interest debt … which might mean extending a loan.
It’s possible to use a lower-interest loan secured by collateral, like an auto loan, to refinance high-interest loans, like credit cards, payday loans or other unsecured loans. If the loan you’re getting with your lender is secured, interest rates and terms are going to better than if the loan is not secured.
For example: You carry a balance on your credit card with an 18% interest rate that you’re unable to pay off. You also have an auto loan with a 5% interest rate. So you could save up to 13%* interest each year by refinancing your credit card debt using the collateral in your car.
Five factors to carefully consider before extending a loan:
- Don’t get into debt you don’t know how you’re going to pay off. It can be easy to put a purchase on your credit card, but then realize you owe $4,000 and can only make the minimum payment. Before you go into any sort of debt, make sure you’re comfortable with the monthly payment and have a plan to pay it off in a timely manner.
- Be mindful of how much longer you’re going to be paying the loan if you extend it. In theory, it makes sense to lower an interest rate with little cost and save the interest you’re currently paying. However, you still want to make sure you have a plan in place to pay down the loan as quickly as you can. What happens if your car becomes worth less than you owe? A broken transmission or another major problem could spell trouble if you need to trade in your car or buy a new one—you might not be able to make a down payment or have the equity to trade it in. That’s a dangerous situation, as it will just result in more debt later on down the road.
- Look at the change in your monthly payment and the amount of interest in the loan overall. Make sure you don’t owe more than the car is worth. Know what the loan is secured by—in this instance, it would be the title.
- Don’t just look at what your payment difference is today. What are the short- and long-term impacts of extending your loan? Have someone, like a Financial Solutions Guide at one of our branches, help you figure out what this decision means today, next year and four years from now.
- Has your credit improved since you got your loan? Interest rates depend on your credit score, so if your score has improved, you could save interest on that alone.
Extending a low-interest auto loan to refinance an existing high-interest loan can be a smart way to save on interest. But don’t forget: The idea of debt is to pay it off and not be in perpetual debt.