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When and how to refinance a personal loan

A personal loan refinance lets you replace your existing loan with a new loan that potentially has a new interest rate or revised repayment timeline. Refinancing might be a good option if interest rates have dropped or are lower than your current rate, or if you need to extend your repayment term.

Securing a lower interest rate through a refinance reduces your cost of borrowing so you’ll pay less on your personal loan overall. Refinancing to a longer loan term offers lower minimum monthly payments. You will likely pay more toward the loan overall by extending the repayment timeline due to interest charges.

What does it mean to refinance a personal loan?

When refinancing a personal loan, you’ll apply for a new loan — either with the same lender or a different one — and then use the funds you receive to pay off your old loan. Once the process is complete, you’ll make payments on your new loan with a new interest rate and terms.

You might want to refinance a loan for any number of reasons, but ideally, it would be to obtain a new, better interest rate as part of the process.

“Usually the goal is reducing your payment or lowering your interest rate. The new loan may also be for a greater amount if the goal is to get more money for a new need,” says Vida Awumey, former vice president and director of policy research for OneMain Financial.

When does refinancing a personal loan make sense?

Refinancing your loan almost always makes sense if it will save you money. There are many scenarios in which it may be possible to achieve substantial savings.

“For example, if interest rates drop and you are able to get a lower interest rate, you would want to consider refinancing,” says Adam Marlowe, principal market development officer for Georgia’s Own Credit Union.

Here are some other times when it may make sense:

  • You have a better credit score. One of the best ways to qualify for a lower interest rate on your personal loan is by improving your credit score. If your score has increased since you initially took out your loan, this could be a good reason to refinance.
  • You want to switch your rate type. Having a variable APR on a personal loan makes it difficult to plan for your monthly payments. Not only that, you might see an upward trend that ends up costing you more. By refinancing, you can switch from a variable to a fixed rate so you can enjoy consistent payment amounts each month.
  • You want to avoid a balloon payment. Some personal loans may come with a balloon payment, requiring you to make a much larger payment than the normal monthly amount at the end of your repayment period. You can refinance ahead of time to avoid this style of personal loan.
  • Your income decreased and you need lower monthly payments. If you’ve lost your job or have reduced income, you may be looking to lower your monthly loan payment. In this case, you may want to refinance your current loan for a longer repayment term, which may not save you money in the long run but could help reduce the monthly payment.
  • You’d like to pay your loan off faster. If you can afford larger monthly payments, you may want to refinance into a shorter loan term. Paying your loan off in a shorter amount of time will save you money in interest overall.
  • You can afford the fees. Taking out a refinance loan may incur fees, such as origination fees or application fees. Your current lender may also charge a prepayment fee if you pay your loan off before the repayment period ends. Before applying for a refinance loan, ensure that refinancing still makes sense financially after factoring in fees.

When does refinancing a personal loan not make sense?

A personal loan will not be worth all the time and effort involved in some cases. Here are some of the times when refinancing may not be the best move:

  • When your loan balance is minimal: If you don’t owe that much on your existing loan, it may not make sense to refinance as some loans charge origination fees on top of the loan balance. Instead of incurring more fees, work on paying off the balance or your original loan more quickly.
  • When your interest rate would be higher: If you’re not getting a more favorable interest rate by refinancing your loan, think carefully about whether you should proceed. This may only make sense if you can’t afford the payments and need to extend the repayment timeline in order to lower the payments.
  • Your repayment timeline is almost over: If you’re reaching the end of the repayment timeline on your existing loan, refinancing will extend the loan’s duration. This means you will pay more money overall on interest charges.

How to refinance a personal loan

If you are ready to refinance your loan, start with the following steps.

1. Figure out how much money you need

When you refinance a loan, you’re essentially paying off the existing loan with a new one that has different terms. So, before you shop for quotes, determine the exact amount of money required to pay off your current loan. Also, see if your original lender charges prepayment penalties that might outweigh the benefits of refinancing.

Knowing your exact loan payoff amount is important because you’ll need to know the loan refinancing amount that’s needed to be free-and-clear of your original loan.

Take action: Log into your personal loan account or call your lender to obtain your outstanding payout balance, and to learn about prepayment fees.  

2. Check your credit score and credit report

Before you consider refinancing your loan, you’ll need to check your credit score and credit report. This is a necessary step to gauge whether you qualify for a lower rate than what you’re currently paying. If the new interest rate isn’t significantly lower, it may not be worth it to refinance.

“Most lenders will quote their best rate, but if you don’t have A-plus credit, that may not be the rate you qualify for,” Marlowe says. “To get your credit score, check to see if your credit card issuer or financial institution provides this for free to their customers.”

You can also request a free credit report annually from each of the three credit bureaus — Equifax, Experian and TransUnion (though weekly reports are free until April 20, 2022).

As you’re shopping around for a new loan, determine whether lenders do a soft pull or hard pull of your credit score when giving you a quote. A hard credit score will negatively affect your score, at least in the short term, so you’ll want to get quotes from lenders that show you your rates using only a soft pull. This process is known as prequalification.

Take action: Request a free credit report through Equifax, Experian or TransUnion.

3. Shop for rates and terms at banks and online lenders

Research is key in refinancing personal loans; before refinancing, compare rates and terms from multiple lenders. Shopping around is important, because the interest rate and terms you’re offered can differ between lenders. Also, a new loan with a lower interest rate isn’t necessarily better if you’re paying more for it overall in fees or by extending it unnecessarily.

“Refinancing a loan may cost additional fees and will change the terms of the loan,” says 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.”

If you’re not looking for lower monthly payments, it may also be unwise to extend the maturity of your new loan past the maturity of the current loan. Even if you get a lower interest rate, you could end up paying more in interest over a longer time frame.

Take action: Compare the features of at least three personal loan refinance offers. To see the overall costs of each loan, try using a personal loan calculator.

4. Speak with your current lender

Don’t overlook your current lender during the research process. It may be willing to offer you a better deal than your existing loan to keep your business.

“You already have an established relationship with that company,” Awumey says. “Your lender will assess your needs and determine your eligibility for a new loan. Many lenders will let you see if you are prequalified for a loan without making a credit inquiry.”

Take action: Contact your existing lender to let them know that you’re considering a personal loan refinance. Ask them whether you’d qualify and the revised rate and terms it’s willing to offer.

5. Apply for the loan

When you’ve settled on a lender whose offer you like best, submit your application and provide any required verification — this could include your Social Security number, paystubs, 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: Read through the fine print of the loan before accepting it, taking note of your payment schedule and any fees, including prepayment penalties. If you’re satisfied with the terms of the loan, you can accept it and will typically receive funds within a few days.

6. Begin making payments on your new loan

Once you receive funds from your new loan, you’ll use them to pay off your existing loan. This should be done as soon as possible to avoid accruing unnecessary interest or making double loan payments.

Receiving your loan funds also enters you into the repayment period of your new loan. You’ll begin making monthly payments immediately with your new interest rate, new repayment timeline and new monthly payment amount. Making on-time, monthly payments keeps your account in good standing.

Take action: Set up auto-pay for your new refinance loan so you never miss a payment.

How refinancing a personal loan affects your credit score

When you refinance, you’ll be subject to a credit check. This can lower your credit score slightly, but the drop should be temporary — especially if you practice good financial habits with your new loan.

“Credit inquiries and new accounts can negatively affect your credit score in the short term, but making on-time payments on a new loan will help your credit score over the long term,” Awumey says.

Keep in mind that a small hit could hurt if you’re also looking to buy a new car or move into a new apartment. Car dealers and landlords check your credit score, and refinancing your loan at the wrong time could make it more difficult to find a vehicle or housing.

Advantages of refinancing a personal loan

While the advantages of refinancing your personal loan will depend on your goals, they can generally include everything from getting a lower interest rate to reducing the overall cost of your loan.

  • Better interest rate: If rates have dropped or you have improved your credit score, you could be able to save money on interest.
  • Faster loan payoff: If you’re comfortable making higher monthly payments and you want to get out of debt faster, you can refinance a personal loan to a shorter term. This has the added benefit of reducing the amount of interest you’ll pay overall.
  • Extended repayment periods: Extending your loan repayment can help your payments feel more manageable if you’re having difficulty making them on time, since lengthening the terms will reduce your monthly bill.
  • Payment stability: Refinancing can provide payment stability if you’re switching from a variable rate to a fixed rate.

Disadvantages of refinancing a personal loan

Refinancing is not the best option for everyone. Before committing to a refinance, consider the following drawbacks:

  • Extra fees: Anytime you take out a new loan, you might have to pay additional lender fees, which can cut into the money-saving benefits you may be trying to achieve.
  • Prepayment penalties: Some loans come with a prepayment penalty when you pay the balance off before the term ends. Since refinancing requires that you pay off the existing loan and replace it with another, it’s best to check the terms of your current loan to determine whether you’ll be penalized for paying it off early.
  • Potentially higher interest costs: Extending a loan period usually results in more interest costs over time. If you’re trying to lower your monthly payment because of financial difficulties, you might still consider refinancing. Just understand that the lower monthly payment likely won’t save you money in the long run.
  • Credit score impacts: Because refinancing counts as a new loan inquiry, it can lower your credit score, even if the impact is minimal and temporary.
  • Research and application time: It takes time to research lenders, compare quotes and send in applications. If your loan is close to being paid off, refinancing may not be worth the hassle.

The bottom line

Before you refinance a personal loan, be sure that you will actually be saving money. A lower monthly payment over a longer term will cost you more over the life of the loan. Additional fees can also make refinancing a costly switch, so cover all of your bases before applying with a new lender. 

If it costs too much or will otherwise affect your finances, hold off on refinancing. And as with everything, research your options carefully. If you do decide refinancing your personal loan is the right choice, work with both lenders to keep the process as smooth and worry-free as possible. 

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