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The Basics of Refinancing a Loan

Chris Gottschalk

Chris Gottschalk About The Author

Aug 20, 2020 6:15:00 AM

If you’ve ever taken out a loan, you know how they work. You go to a credit union or bank and borrow a certain amount of money that you’ll pay back in monthly installments over a set amount of time. You’ll also have to pay a certain percentage of that loan back as interest.

What many people don’t realize, though, is that their financial situation could change for the better during the term of the loan. Even if you just continue to pay your bills on time, your credit score will improve. If it improves enough, you can get better terms on loans you take out in the future.

Refinance blocks | First Alliance Credit UnionThe problem is that even if you can get good terms on a loan with your new credit score, you still have the loan you took out with terms based on your original, less good, credit score. Wouldn’t it be nice if you could use your new credit score to get better terms on your old loan?

Fortunately, there is a way. If you shop around, you may find a financial institution that will refinance your loan.

When you refinance a loan, you simply use your higher credit score to apply for a loan that has better terms than your original loan. You then use the new loan to pay off the old loan.


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Advantages of Refinancing a Loan

Getting a loan with better terms can give you several benefits:

  • You can get a lower interest rate, which can lower the overall amount you’ll have to pay. This can be especially advantageous with long-term loans, but it can also help lower monthly payments on short-term loans.
  • You can extend the term of the loan, which will give you more time to repay your debt and lower your monthly payment. However, you’ll also end up paying more in interest fees over the life of the loan.
  • You can change an adjustable-rate interest loan to a fixed rate, which will fix the amount of money you have to pay each month. This is extremely useful if you believe interest rates are going to shoot up in the future.
  • You can pay off an existing loan that has come due, especially loans like balloon loans that require large lump-sum payments. For instance, if you have a business loan due in only a few years, you can refinance the loan with a longer term after you’ve had time to establish your business and demonstrate that you can make your payments on time.

Disadvantage of Refinancing a Loan

Even though refinancing can get you ahead financially, it may also have some drawbacks.

The biggest drawback is that getting a new loan might involve transaction fees. These vary by loan, but you should expect them to be anywhere from 3% to 6% of the loan itself. You should be especially aware of this when dealing with large loans like mortgages, where the closing costs might be thousands of dollars.

You might also sacrifice some benefits the old loan offers that the new loan does not. For instance, if you refinance a federal student loan, for instance, you’ll be getting rid of the flexibility federal loans offer if you’re going through a period of financial hardship. You’ll also get rid of the opportunity to have some or all of your loan forgiven if you get into a public service career.

Refinance Your Loan With First Alliance Credit Union

Refinancing your loan can offer you several benefits and let you use an improved credit score to your advantage. It also has potential drawbacks, though, so you'll need to make sure that refinancing will help you come out ahead financially.

Man researching | First Alliance Credit Union In order to be sure refinancing will help you, you'll need to shop around. Visit different financial institutions and see what terms they can offer on a new loan, then compare them to your original loan and determine which is best for your situation. You can also contact a First Alliance Credit Union lending advisor today to see what rates and terms they can offer you on a loan.

You should also know that First Alliance now has video capabilities for appointments to promote social distancing, so if you schedule an appointment with a Member Experience Advisor, Member Advisor or Lending Advisor you may be able to talk with them through a video conference. This allows us to have a face-to-face interaction with our members and still ensure the safety of our team.

Want more information? Listen to this episode of our Good Money Moves podcast talking about the basics of credit scores.