Refinancing a personal loan allows you to replace your existing loan with a new one, which could result in a lower interest rate and lower monthly payments.
Refinancing a personal loan can be a good option if your credit score has recently improved and you can get a more competitive interest rate. You can also extend your repayment term, but your total payment may increase.
Ultimately, the right decision for you will depend on your financial situation. If you qualify for better terms, refinancing may be a good idea. If not, you may want to consider personal loan alternatives.
What does it mean to refinance a personal loan?
When you refinance a personal loan, you typically apply for a new loan with a different lender, use the funds you receive to pay off the old loan, and then make payments on the new loan once the process is complete.
There are many reasons to refinance a loan, but ideally, you want to get a new, better interest rate as part of the refinancing process. In some cases, you might choose to refinance in order to borrow more money for new expenses or financial needs.
How to refinance a personal loan
If you’re refinancing a personal loan, you’ll need to know how much you need and check your credit score before you start comparing lenders. Once you’ve decided where to apply, the application process is similar to taking out a regular personal loan.
1. Calculate the amount you need
Before looking for quotes, determine the exact amount you need to repay your current loan. The repayment amount is important because it helps you choose a lender that will offer you competitive terms for your refinance.
You should also find out whether your original lender charges prepayment penalties, which can add up quickly and outweigh the benefits of refinancing.
Take Action: Log into your account online or call your lender to view your outstanding balance, repayment estimates and prepayment fees.
2. Check your credit score and credit report
Before you refinance, you should also check your credit score and credit report. This is a necessary step to determine whether you qualify for a lower interest rate than what you’re currently paying. If the new interest rate isn’t significantly lower, it may not be worth refinancing.
You can also request a free weekly credit report from the three credit bureaus: Equifax, Experian, and TransUnion.
When you’re looking for a new loan, find out whether the lender will do a soft or hard pull on your credit score when giving you a quote. Many lenders offer a pre-qualification process, which allows you to see interest rates without affecting your credit score.
A hard credit score will have a negative impact on your score, at least in the short term, so you should get quotes from lenders that only use soft pulls to offer you interest rates.
Take Action: Request a free credit report through Equifax, Experian, or TransUnion.
3. Compare prices and terms
Research is key when refinancing a personal loan: Compare interest rates and terms from multiple lenders before refinancing to ensure you’re getting the best terms for your financial situation.
Compare fees, such as origination fees, which can increase your annual percentage rate (APR). The amount you can borrow and the terms of your loan also factor into your decision. Choose a lender that offers you the amount you need to refinance.
If you want to lower your monthly payments, carefully consider whether to extend the loan term. Even if the APR is lower, you could end up paying more in interest over a longer repayment period.
Take Action: Compare the features of at least three personal loan refinance offers. Try using a personal loan calculator to see the overall cost of each loan.
4. Talk to your current lender
During your research, don’t overlook your current lender. While it’s rare that you’ll be able to refinance with your current lender, they may be able to offer you better terms.
Because you already have a relationship with your current lender, it may be easier to find out if you qualify for a second personal loan that doesn’t require a new credit check.
Take Action: Contact your existing lender and ask if they would be willing to refinance your loan or modify your current interest rates and terms.
5. Apply for a loan
Once you’ve chosen a lender with the right options, you’ll submit an application and provide the necessary documentation, including your Social Security number, pay stubs, bank statements, tax documents, etc.
While pre-qualification is an important step, it’s not a formal application. To move forward, you’ll need to submit a complete application and undergo a rigorous credit check to ensure you qualify.
Take Action: Before accepting a loan, read the loan fine print carefully. Pay attention to the payment schedule and fees (including prepayment penalties). If you’re happy with the loan terms, you can accept the loan, and you can usually receive your funds within a few days.
6. Start making payments on your new loan
Once you receive the funds from the new loan, use it to pay off the existing loan. You should pay it off as quickly as possible to avoid accruing unnecessary interest or double paying the loan.
Once you receive your loan funds, you will also begin the repayment period for your new loan. The exact dates and terms will vary depending on your loan agreement. As with your previous loan, making your payments on time will keep your account in good standing.
Take Action: Set up automatic payments on your new refinance loan so you don’t miss a payment.
When to refinance your personal loan
If it will save you money, refinancing your loan almost always makes sense.
“For example, if interest rates fall and you’re able to borrow at a lower rate, you may want to consider refinancing,” says Adam Marlow, chief strategy officer at Georgia United Credit Union.
Other situations in which refinancing a personal loan may make sense include:
- Your credit score will increase: One of the best ways to lower your interest rate on a personal loan is to improve your credit score, and if your score has improved since you first took out your loan, that could be a good reason to refinance.
- Revenues have decreased: If you’ve lost your job or experienced a reduction in income, you could refinance your current loan to extend your repayment term. While it might not save you money in the long run, it could result in a lower monthly payment.
- I want to pay off my loan quickly: If you can afford to pay more in monthly payments, it may be a good idea to refinance to a shorter loan term. Paying off your loan over a shorter period of time can help you save money on interest overall.
- Affordable to pay the fees: Refinancing may come with fees, such as origination fees or application fees. You may also be charged a prepayment fee by your current lender if you pay off your loan before the end of your repayment term. Before applying for a refinance loan, make sure that refinancing makes financial sense, even after taking into account the fees.
When should you wait to refinance your personal loan?
Some personal loans just aren’t worth the time and effort it takes to refinance. Here are some examples of when refinancing might not be your best option:
- your The loan balance is low: If you don’t owe much on your existing loan, refinancing may not make sense because some lenders charge an origination fee on top of the loan balance. Instead of paying more in fees, try to pay off the balance of your original loan more quickly.
- your Interest rates are higher: If you can’t get a better interest rate by refinancing your loan, think carefully. Refinancing at a higher interest rate only makes sense if you can’t afford it and need to extend your repayment term.
- your The loan term is almost over: If your existing loan is nearing the end of its term, refinancing could increase the amount you pay in interest overall.
How refinancing a personal loan can affect your credit score
When you refinance, a credit check will be conducted, which may cause a slight drop in your credit score, but the drop should be temporary, especially if you’ve established good financial habits, like making on-time payments on your new loan.
If you’re also thinking about buying a car or moving to a new apartment, keep in mind that even small hits can hurt. Car dealerships and landlords check your credit score, and refinancing at the wrong time could make it harder to find a car or a home.
Benefits of refinancing a personal loan
The benefits of refinancing a personal loan vary depending on your goals, but generally include everything from lowering your interest rate to reducing the overall cost of your loan.
- Better interest rates: If interest rates drop or your credit score improves, you may be able to save money on interest by refinancing at a lower average APR.
- Faster loan repayment: If you don’t mind higher monthly payments and want to pay off your debt faster, you can refinance your personal loan to a shorter term.
- Extending the repayment period period: Stretching out the term of your loan can make your payments more manageable, but it usually means you’ll pay more in interest.
- Payment Stability: If you’re switching from a variable to a fixed rate, refinancing can give you payment stability.
- Improve your credit score: Although the initial credit check that comes with refinancing may lower your score, making payments on your new loan on time will help improve your score in the long run.
Disadvantages of refinancing a personal loan
Refinancing isn’t the best option for everyone. Before you refinance, consider these drawbacks:
- Additional charges: With every new loan, you may have to pay additional lender fees, which could reduce the savings benefits you’re trying to achieve.
- Prepayment Penalty: Some loans have prepayment penalties. Check the terms of your current loan to see if there are any penalties for early repayment.
- Potentially high interest costs: Extending your loan term typically increases your interest costs over time. If you’re looking to lower your monthly payments due to financial hardship, you may want to consider refinancing.
- Credit score impact: Refinancing counts as a new loan inquiry, so even if the impact is minimal and temporary, it could lower your credit score.
- Study and Application Time: Researching lenders, comparing quotes, and submitting applications takes time, and if your loan is close to due, refinancing may not be worth the hassle.
Conclusion
Before refinancing your personal loan, make sure you find out if you can actually save money, preferably through a lower interest rate. And remember that keeping your monthly payments low for a long period of time will ultimately end up costing you more over the life of the loan.
Additional fees associated with the new loan and prepayment penalties on your current loan can also make refinancing costly. Carefully consider all costs associated with the refinancing process before making a decision about whether to go ahead with the refinance.
