Refinance? Consolidate? What They Mean — And When They’re Right For You

Loan refinancing and debt consolidation are two terms that are often used interchangeably when it comes to paying down debt.

Sure, both options can help you better manage debt with lower interest rates and lower fees. In fact, Bruce McClary, vice president of communications at the National Foundation for Credit Counseling, says these tactics can help consumers get a fresh start when it comes to finances.

“You could potentially save a lot of money over time,” says McClary. “That helps you pay off the debt faster; it helps you manage the debt more successfully. There are a lot of good things that could come out of refinancing or consolidating.”

Although both are solid ways to handle debt, they’re different. Consumers need to be aware of their differences before making any big money moves.

Here’s your personal finance 101 lesson on refinancing versus consolidating your debt:

What is Loan Refinancing?

I’m going to be honest: I can’t explain it any better than McClary:

When refinancing a loan, “You’re taking an existing loan, and you’re repackaging it with new terms and conditions,” he says.

You can go back to your original lender or shop around for a new one. When you refinance, you’re paying off the original loan in full and are replacing it with a new one — which ideally has better rates, terms and fees.

You can refinance a lot of types of loans, including home loans, car loans, student loans and credit cards.

Now… What Is Debt Consolidation?

Similar to refinancing, debt consolidation should ideally result in more favorable terms, lower payments and lower fees.

But debt consolidation is the act of combining multiple loans into one. You’ll pay off all those loans with one new loan. Then, you’re left with one account to manage.

“It’s paying off multiple loans and lines of credit with a new loan,” McClary says. “When you’re consolidating, you’ll end up having a single payment for the total amount of debt consolidated across the accounts.”

You cannot consolidate your home loans or auto loans, according to the organization Money Meters — another key difference between refinancing and consolidating. You can, however, consolidate your credit cards, federal student loans, payday loans and hospital bills.

When’s the Best Time to Refinance or Consolidate?

The answer for this one is going to be different for everyone, but McClary offered a few nuggets of advice.

Most importantly, you’ll want to make sure refinancing or consolidating your debt is actually going to help you. Will it result in lower payments? Lower interest rates? Fewer fees? Overall, you’re looking for more favorable conditions to help you tackle your debt.

You’ll find better rates when the market is favorable, McClary explains.

Additionally, if you’ve managed to increase your credit score since initially taking out the loan, that works in your favor.

When it comes to consolidating, it’s really important to do the math and to map out your payments. Factor in the length of your loan along with the new interest rate (versus your existing interest rates and payments and fees).

“If you’re not careful, you could end up in a debt consolidation that’s not as favorable as you had before,” McClary says. “That highlights the importance of shopping around competitively for the best terms and conditions and having a good understanding of interest rates and terms and fees.”

It’s also important to be aware of your existing loan’s (or loans’) terms and conditions. It might be you’re penalized if you haven’t had the loan long enough and pay it off too early by refinancing or consolidating.

Important Considerations

McClary emphasizes the importance of shopping for refinancing and consolidating options.

Sure, you can approach your existing lender and see if they can help you out, but you also might want to check out an online marketplace. You can bring better offers to your lender as a bargaining chip. Or you can simply opt for a new lender.

It’s also important to remember when you refinance or apply for a debt-consolidation loan, it’ll be marked as a hard inquiry on your credit report, which has the potential to negatively impact your credit score, “though it’d be minor for a loan application,” McClary says.

That minor drop can pay off and result in a higher credit score over time, if you’re making more payments on time.

If you’re struggling to pay off several credit cards, consolidating those could be a good option. But McClary encourages those who are consolidating several credit card accounts to move forward with caution.

Once you’ve paid off four accounts in one fell swoop, for example, you shouldn’t necessarily start relying on those credit cards again; paying off debt doesn’t mean you can rack it up again. It also doesn’t necessarily mean you should shut all the accounts down at once. That could have a negative impact on your credit score.

Before Taking Steps Toward Refinancing or Consolidating…

If you think loan refinancing or debt consolidation could be a smart money move for you, great.

Before you move forward, you’ll want to check your own credit report to see where you stand.

“It gives you an opportunity to have as complete of a picture as possible,” McClary says. “It gives you the opportunity to address any issues that might be having a negative impact on your credit score.”

Then, you can start taking steps to repair your credit — which might include refinancing or consolidating.

If at that point you’re having trouble finding loans you qualify for and can’t find an affordable way out of your debt, McClary encourages consumers to reach out to a nonprofit credit counseling agency. These organizations can offer alternatives to pursue until you have a chance of qualifying for a better option.

Want some examples of folks who have benefited from refinancing or consolidating their debt? Check out these stories:

• We recently chatted with Nick. He was sitting in $26,000 worth of credit card debt. He took out a debt consolidation loan, and he’s managed to wrap the debt together and pay a lesser amount in interest and more toward principal.
• We’ve also talked with two grads who were buried in student loan debt. They decided to refinance their loans, and one cut his monthly payments in half (from $850 to $400) while another will save up to $7,000 overall.

Carson Kohler (@CarsonKohler) is a staff writer at The Penny Hoarder.