Personal loans can be used to replace your existing loan with one that has different terms. This might be beneficial if interest rates have dropped or you need to change your repayment timeline.
Refinancing your personal loan can help you secure a lower interest rate, which in turn will reduce the overall cost of borrowing. Extending the loan term can also lower your minimum monthly payments. However, keep in mind that doing so will likely increase the amount you pay toward the loan overall due to additional interest charges.
What does it mean to refinance a personal loan?
Refinancing a personal loan involves taking out a new loan to pay off the old one. This can be done with the same lender or a different one. The new loan will have different interest rates and terms.
One reason to refinance a personal loan is to get a new, lower interest rate. This can save money over the life of the loan, and make monthly payments more manageable.
The goal of most loan modification programs is to lower your monthly payments and/or interest rate. In some cases, you may also be able to borrow additional funds for a new need.
Vida Awumey, former vice president and director of policy research for OneMain Financial, says that loan modification can be a great way to improve your financial situation.
When is it a good idea to refinance a personal loan?
There are many circumstances in which refinancing your loan can lead to substantial savings. Almost always, it makes sense to refinance a personal loan if doing so will save you money.
“When interest rates fall, refinancing may be a good option to lower your monthly payments,” says Adam Marlowe, principal market development officer at Georgia’s Own Credit Union. “But it’s important to compare all the costs of refinancing before making a decision.”
Here are some of the times when it may make sense to refinance a personal loan:
- You have a better credit score. There are many benefits to refinancing your personal loan, including the potential for a lower interest rate. Your credit score is a significant factor in determining your interest rate, so improving your credit score can lead to significant savings. Another reason to refinance a personal loan is to take advantage of a change in your financial situation.
- You want to switch your rate type. When you have a variable APR on a personal loan, it can be tough to plan your monthly payments. Not only that, but you may see an upward trend in your interest rate that ends up costing you more money. However, when you refinance a personal loan, you can switch from a variable to a fixed rate.
- You want to avoid a balloon payment. Personal loans with a balloon payment at the end of the repayment period can be refinanced to avoid this.
- Your income decreased and you need lower monthly payments. Losing your job or experiencing a drop in income can be difficult. One way to ease the financial burden is to refinance a personal loan for a longer repayment term. This may not save you money in the long run, but it could help reduce your monthly payment.
- You’d like to pay your loan off faster. The benefits of refinancing into a shorter loan term are twofold: you’ll save money on interest overall, and you’ll have the satisfaction of paying off your loan more quickly.
- You can afford the fees. There are fees associated with refinancing your loans, such as origination fees or application fees. Your current lender may also charge a prepayment fee. Make sure that refinancing is still the best option for you after factoring in all of the fees.
When is it a bad idea to refinance a personal loan?
When looking to refinance a personal loan, it may not be worth the time and effort involved depending on your case. Here are some of the factors that make refinancing not a good move:
- When your loan balance is minimal: Paying off your loan more quickly may be a better option than refinancing, particularly if you don’t owe much on your existing loan. Some loans charge origination fees in addition to the loan balance, so incurring more fees by refinancing may not make sense.
- When your interest rate would be higher: There are a lot of factors to consider before refinancing your loan. A more favorable interest rate may not be one of them. You should think carefully about whether you should proceed with refinancing, especially since it may only make sense financially if you can’t afford the current payments and need to extend the repayment timeline.
- Your repayment timeline is almost over: As you approach the end of your current loan’s repayment timeline, refinancing may be an option to consider. This would extend the loan’s duration, but also result in paying more money overall in interest charges.
How to refinance a personal loan step by step
Start with the following steps if you are ready to refinance a personal loan:
1. Calculate how much money you need
The process of refinancing a loan involves taking out a new loan to pay off the existing one. This new loan often has different terms than the original, so it’s important to compare offers from multiple lenders before making a decision. Be sure to factor in any prepayment penalties charged by your current lender, as they may offset the benefits of refinancing.
It’s important to know exactly how much you owe on your loan so that you can budget for refinancing, which will allow you to pay off your original loan.
Take action: Your personal loan account contains important information regarding your outstanding balance and any prepayment fees that may apply. Logging in or calling your lender will allow you to obtain this information and make any necessary changes to your account.
2. Check your credit score and report
There are a few things to consider before refinancing your loan. Checking your credit score and credit report is a good place to start. This will give you an idea of whether you qualify for a lower interest rate. However, keep in mind that even a small reduction in interest may not always be worth it if the repayment term is longer.
“When shopping for a loan, it’s important to know what rate you qualify for,” Marlowe says. “Your credit score is a major factor in determining your interest rate. Many credit card issuers and financial institutions provide free credit scores for their customers.”
When you’re shopping for a new loan, it’s important to know whether the lender will do a soft pull or hard pull of your credit score. A hard inquiry can negatively affect your score, so you’ll want to get quotes from lenders that only use a soft inquiry. This process is called prequalification.
Take action: Get your free credit report from Equifax, Experian, or TransUnion today.
3. Shop around for rates and terms from different lenders
Before deciding to refinance a personal loan, it is important to do your homework and compare rates and terms from multiple lenders. Keep in mind that the interest rate and terms offered by different lenders can vary, so it’s important to shop around. Also, a new loan with a lower interest rate may not necessarily be the best option – you may end up paying more for it overall in fees or by extending the loan unnecessarily.
Refinancing a loan can save you money in the long run, but it’s important to consider all the factors involved before making a decision. According to Jeff Wood, CPA, and partner at Lift Financial, “Your current loan may have a prepayment penalty in order to replace it. All of these factors must be considered to determine if a refinance makes sense, both personally and financially.”
You may not want to extend the maturity of your new loan past the maturity of your current loan. Even though you could get a lower interest rate, in the long run, you would end up paying more in interest.
Take action: To get the best deal on a personal loan, it’s important to shop around and understand the features of different offers before choosing to refinance a personal loan. A personal loan calculator can help you see the overall cost of each loan and make comparisons.
4. Talk to your current lender
As you shop around for a new loan, be sure to check in with your current lender. They may be willing to offer you a more competitive rate to keep your business.
“When it comes to getting a new loan, your existing relationship with a particular lender will be taken into account,” says Awumey. “After assessing your needs, the lender will then determine whether or not you qualify for the new loan. In many cases, prequalification can be achieved without triggering a formal credit inquiry.”
Take action: Reach out to your current lender to let them know you’re thinking about refinancing your personal loan. Ask them whether you’d qualify and what the revised rate and terms would be.
5. Apply for the loan
After you have found the lender whose offer you like the most, go ahead and submit your application. You may be asked to verify, such as your Social Security number, pay stubs, bank statements, or tax documents.
Remember, the loan comparison step discussed earlier isn’t the same as a formal refinancing application. To officially move forward with a loan offer, undergo the loan underwriting process, and receive funding from your chosen lender, you’ll need to submit a formal application.
Take action: Be sure to thoroughly review the loan agreement before accepting any funds. Pay close attention to the payment schedule and any fees that may be charged, including prepayment penalties. Once you are satisfied with the terms of the loan, you can accept it and typically receive the money within a few days.
6. Start making payments on your new personal loan
As soon as you receive the money from your new loan, pay off your existing loan with it. This will save you from accruing extra interest or making double loan payments.
When you receive your loan funds, you will also begin the repayment period for your new loan. You will start making monthly payments right away, with a new interest rate, repayment timeline, and monthly payment amount. Keeping up with your monthly payments on time will help keep your account in good standing.
Take action: Set up the auto-pay feature when you refinance a personal loan so you don’t miss a payment.
Does refinancing a personal loan affect your credit score?
Refinancing a personal loan can be a great way to save money – but it’s important to know that you’ll be subject to a credit check. This may cause your credit score to drop slightly, but as long as you keep up good financial habits with your new loan, the impact should be temporary.
Even a small hit to your credit score can have big consequences – like making it harder to buy a new car or get approved for an apartment. That’s because car dealers and landlords often check your credit score when making decisions about financing or renting. So refinancing your loan at the wrong time could really put a damper on your plans.
Benefits of refinancing a personal loan
There are many benefits to refinancing your personal loan, including getting a lower interest rate and reducing the overall cost of your loan.
- Better interest rate: You could save money on interest by shopping around for a better rate, or by improving your credit score.
- Faster loan payoff: Changing the terms of your personal loan can help you pay off debt faster and save on interest. Refinancing to a shorter-term loan can increase your monthly payments, but you’ll pay less in the long run.
- Extended repayment periods: Extending the term of your loan can help make your monthly payments more manageable, especially if you are having difficulty making them on time. This is because lengthening the repayment period will reduce the amount you have to pay each month.
- Payment stability: Refinancing can provide payment stability and peace of mind by swapping out a variable rate for a fixed rate.
Risks of refinancing a personal loan
Before deciding to refinance a personal loan, it is important to be aware of the potential risks. These include:
- Extra fees: Whenever you apply for a new loan, you may have to pay extra fees charged by the lender. These fees can reduce or cancel out the money-saving benefits you were hoping to get from taking out the loan.
- Prepayment penalties: Prepaying your loan before the term ends may result in a prepayment penalty. Be sure to check the terms of your current loan to see whether you will be penalized for doing so.
- Potentially higher interest costs: When you extend the term of a loan, you typically end up paying more in interest costs over time. However, there may be circumstances where refinancing with a lower monthly payment makes sense, even though it may not save you money in the long run.
- Credit score impacts: Refinancing your mortgage can hurt your credit score, even though the effect may be small and only temporary.
- Research and application time: Searching for the right lender, comparing quotes, and filling out applications can be time-consuming. Unless you stand to save a significant amount of money, refinancing may not be worth the hassle.
Refinance a personal loan — The bottom line
When considering refinancing a personal loan, be sure to compare the total cost of the new loan with the remaining balance on the old loan. Often, refinancing can lead to paying more in interest over the life of the loan. Be sure to factor in any additional fees as well when making your decision.
Before deciding to refinance a personal loan, be sure to consider all of the potential implications carefully. This includes taking a close look at how it may affect your finances. Once you have all the information you need, you can then decide whether or not refinancing is the right choice for you.