When And How To Refinance A Personal Loan

Refinancing a personal loan replaces your existing loan with a new loan — potentially with a lower interest rate and smaller monthly payment.

This might be a good option if your credit score has recently improved, which can help you score a more competitive interest rate. You can also choose to extend your repayment term, although this may mean paying more overall.

Ultimately, the right decision depends on your financial situation. If you qualify for better terms, it may be a good idea to refinance. Otherwise, there are alternatives to personal loans that you can consider.

What does it mean to refinance a personal loan?

When refinancing a personal loan, you’ll apply for a new loan — usually with a different lender — and then use the funds to pay off your old loan. Once the process is complete, you’ll make payments on your new loan.

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. In some cases, you may also choose to refinance in order to borrow more money for a new expense or financial need.

Pros and cons of refinancing a personal loan

Pros

• Potentially lower interest rate
• Faster loan payoff
• Extended repayment period
• Payment stability
• Improved credit score

Cons

• Extra fees
• Prepayment penalties
• Potentially higher interest costs
• Credit score impacts
• Research and application time

While the advantages of refinancing your personal loan will depend on your goals, they generally include everything from scoring a lower interest rate and changing your loan term to reducing the overall cost of your loan. Your credit score could also benefit over time as you continue to make timely payments.

That said, refinancing is not the best option for everyone. Before committing to a refinance, consider the added fees, including prepayment penalties (if applicable), that could cut into the money-saving benefits you may be trying to achieve. Also, keep in mind that a longer loan term often means higher borrowing costs over the life of the loan. And when you apply for a refinance, the new hard inquiry could ding your credit score.

How to refinance a personal loan

When you refinance a personal loan, you should know how much you need and check your credit score before comparing lenders. After you know where you want to apply, the application process is similar to borrowing a personal loan.

1. Figure out how much money you need

Before you shop for quotes, determine the exact amount of money you need by asking your lender for the current payoff amount. Also, determine whether you’ll be charged a prepayment penalty. Although this fee is rare, it can tip the scales and eliminate any benefit of refinancing.

2. Check your credit score and credit report

This is a necessary step to gauge whether you’ll 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.

You can request free weekly copies of your credit reports from each of the three credit bureaus — Equifax, Experian and TransUnion. Your bank or credit card issuer may give you free access to your credit score, or you can buy it from one of the credit bureaus.

3. Compare rates and terms

Research is key when you refinance a personal loan. Before refinancing, compare rates and terms from multiple lenders to ensure you get the best deal for your financial situation.

Compare fees, such as origination fees, which can increase your annual percentage rate (APR), along with rates and terms from multiple lenders to find the best deal for your financial situation. If you’re looking to lower your monthly payments, carefully consider whether you should extend your loan term. Even if you get a lower APR, you’ll end up paying more in interest over a longer repayment period.

4. Speak with your current lender

Although it may not wind up being the best deal, you may be able to refinance with your current lender. It’s worth an ask, though, as you may have luck securing a second personal loan off the strength of your existing relationship.

5. Apply for the loan

Prequalification is an important step, but it isn’t a formal application. To move forward with the process, you must submit a full application — and undergo a hard credit check — to confirm that you qualify.

Before applying, gather any information and documents the lender will need to make a decision. Most lenders request the following:

• A copy of your driver’s license, state-issued ID or passport
• Proof of address, like a mortgage statement, rental agreement, utility bill, auto insurance bill or bank statement
• Your Social Security number
• Paystubs, W2 forms or tax returns
• Bank statements, 1099s or tax returns (if self-employed)
• Your employer’s contact information

6. Start making payments on your new loan

Once you receive the funds from your new loan, 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. Keep in mind that the repayment period on your new loan will also start — make all payments on time to keep your account in good standing.

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, like making on-time payments.

Keep in mind that even a small hit could hurt if you’re also looking to buy a 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.

Should you refinance your personal loan?

Refinancing your loan almost always makes sense if it will save you money.

“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, chief strategy officer for Georgia United Credit Union.

However, some personal loans may not be worth all the time and effort involved in refinancing. Before committing to a new loan, consider the following scenarios:

When to refinance a personal loan

• You have a better credit score. One of the best ways to qualify for a lower interest rate on a 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 need a lower payment. If you’ve lost your job or have reduced income, you can refinance your current loan for a longer repayment term to reduce your monthly costs. Keep in mind that a longer term will result in paying more interest over the life of the loan, but the tradeoff may be worthwhile if you can’t afford your current payment.
• You’d like to pay your loan off faster. On the other hand, 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. Some lenders charge origination fees, which can make borrowing more expensive. 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 you should avoid refinancing a personal loan

• Your loan balance is low. If you don’t owe much on your existing loan, it may not make financial sense to refinance. Instead of incurring more fees, work on paying off the balance on your original loan more quickly.
• Your interest rate would increase. If you don’t qualify for a more favorable interest rate, think carefully about proceeding. Refinancing at a higher rate only makes sense if you can’t afford the payments and need to extend your repayment term.
• Your loan term is almost finished. If you’re reaching the end of the loan term on your existing loan, refinancing may mean paying more money overall on interest.

Bottom line

Before you refinance a personal loan, make sure that it will actually help you save money — ideally through a lower interest rate. And remember that a lower monthly payment over a longer term will ultimately cost you more over the life of the loan.

Additional fees associated with the new loan, as well as prepayment penalties for your current loan, can also make refinancing a costly switch. Be sure to review all expenses associated with the refinancing process carefully before making a decision to proceed.