Should you refinance your debt?

Photo by Ehud Neuhaus on Unsplash

With rates as low as they are, it is common to see if you should refinance your debt. Regardless, this is a great question to ask yourself every few years to see if it will improve your life by refinancing. To know whether you should refinance your debt, you can follow this natural decision tree.

Step 1: Determine your financial goals

The first step to accomplish is figuring out what you want to achieve financially. Are you looking to make the most money you possibly can? How about being one hundred percent debt-free? Where do you want to go financially?

Once you know what goals you want to work towards, you will be able to accomplish them much more rapidly because you won’t waste your time on things that take away from your goals.

Step 2: Decide why you are refinancing

The second step is to determine why you want to refinance your debt. Some of the most common reasons to refinance debt are to lower payments or to pay your loan off faster. What is your motivation?

Step 3: Run the numbers

Now that you know where you are going financially and have decided why you want to refinance, you can run the numbers to see if refinancing makes financial sense for you to achieve your financial goals.

When running your numbers, it is essential to consider your goals and decide what numbers to run. This is where a financial professional can add immense value to you because we are very comfortable with different scenarios and running different numbers.

If you are looking to maximize your money’s value by leveraging your debt, you would want to calculate how much investing the difference in payment would increase your investment account at the end of the loan term.

If you want to pay your debt off as soon as possible, then it is vital to figure out how much faster you would pay the debt off if you refinanced and continued making your same payment.

If the numbers don’t make sense, you can end the refinance process right now. If they make sense, go to the next step and see just how significant that change will be to accomplish your overall financial goals.

Step 4: See how refinancing will impact you achieving your goals

If the numbers look good, it is time to see if refinancing will allow you to achieve your financial goals faster or slower. When looking at this, you will want to consider your financial life holistically, not just looking at this one loan.

If refinancing this loan will cost you $5,000 and save you three years on this loan but wind up only changing your final debt payoff by six months because you will need to rebuild your savings for the upfront cost, it may not make sense to refinance.

Likewise, if refinancing will free up $100/month in extra cash flow, but add two years on your loan, causing you to have difficulty making ends meet for another two years, it may not make sense to refinance.

Step 5: Refinance your loan or walk away, knowing that you are doing the right thing

Now that you’ve decided that refinancing is right for you or not, you can execute on your strategy. So go and make it happen!

As a side note, in my experience, it is best to systemize payments and investments whenever possible. This will give you peace of mind and reduce your mental fortitude requirements. This takes away one more potential point of failure from you achieving your financial goals.

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