Is refinancing a loan worth it? The maths, with an example
A lower rate does not automatically mean you will save. What you need to compare is the total interest.
In short
Refinancing is worth it when the new rate is clearly lower, the term stays the same and fees cost less than the interest saved. Example: 10 000 over three years at twenty-four percent costs 4 124 in interest; at seventeen percent it costs 2 835 — a saving of 1 289 before fees. But stretch the new loan to five years and the payment drops to 249 while interest rises to 4 912, more than not refinancing at all.
Refinancing means taking out a new loan to pay off the old one. Lenders push it because it wins them customers. It does not always pay off for you — and you can check in ten minutes.
A worked example
You owe 10 000 with 36 months left at twenty-four percent. Another lender offers seventeen.
No refinancing
Payment 392
Interest 4 124
Same term, 17%
Payment 357
Interest 2 835
Stretched to 5 years, 17%
Payment 249
Interest 4 912
Lowering the rate on the same term saves 1 289. Stretching the term cuts the payment by more than a third, but costs 788 more than doing nothing.
What to subtract from the savings
- Origination and other fees on the new loan.
- Insurance, if it is required to get the rate — and what the rate is without it.
- Costs on the old loan: an early repayment penalty, if your contract has one.
If the saving is still clear after that, refinancing is worth it.
When it pays off
- The rate drops by several points and there is a long way to go.
- Several debts are combined into one at a lower rate — easier to track and less interest.
- The current payment is so heavy that a missed payment is a real risk. Then even a longer term can make sense: a late payment costs more. How to tell when the load is too much: debt-to-income ratio.
When it does not
- Less than a year is left: the final payments contain little interest.
- Fees and insurance eat the saving.
- The aim is to "free up money" to spend. A year later you have the same debt, only longer, with new spending on top.
The alternative
If you cannot get a lower rate, extra payments give a guaranteed saving: pay extra on a loan. And if you have several debts, the order to pay them in: how to get out of debt.
How it looks in the app
In Caudal a loan goes in Debts with its balance, monthly payment and day of the month. After refinancing, close the old debt and add the new one with its payment — the "how long your money lasts" forecast on the home screen picks up the change straight away. If several loans were combined into one, Debts shows a single line instead of several, and the total you owe is one number.
Common questions
- Is it worth refinancing a loan?
- It is when the new rate is clearly lower, the term does not get longer, and fees and insurance cost less than the interest you save. In the example, cutting the rate from twenty-four to seventeen percent over three years saves 1 289.
- Why can refinancing cost more?
- Because of a longer term: the payment drops, but interest runs for longer. In the example, stretching from three to five years means paying 788 more than not refinancing. Fees and required insurance also eat into the saving.
- Should I refinance credit card debt?
- Often yes: cards usually carry the highest rates, so moving the balance to a cheaper fixed-term loan saves interest. The condition is not running the card up again, or you end up with two debts.
Try it on your own money
Caudal is an expense tracker in Spanish, English and Russian. Several currencies, goals, debts, a shared household budget. Recording an expense takes three seconds.
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