Borrowers with high-interest personal loans can refinance with a new loan offering more favorable terms such as a lower APR or extended repayment period. This can result in paying less interest overall or reducing monthly payments by transferring the debt to a new loan.

What is Personal Loan Refinancing?

Refinancing a loan means getting a new loan and using those funds to pay off your existing debt. Once your new loan has closed and you've paid off the balance on the original balance, you'll start making payments on the new loan.

There are a few reasons to refinance a personal loan, but many borrowers refinance to obtain more favorable terms than the original loan. For example, if interest rates have dropped since you got your loan, you could refinance for a lower rate. Similarly, you could refinance to shorten the term (if you can now afford higher payments) or lengthen the term (if you need your monthly payments to be lower).

You can refinance your loan either through your current lender or a different one. It's best to compare refinancing offers from several lenders to find the best deal.

How to Refinance a Personal Loan

Before refinancing a personal loan, it's essential to determine your borrowing needs and assess your credit score. Once you've identified potential lenders, the application process is similar to a standard personal loan.

Start with these steps if you feel refinancing makes financial sense:

Determine The Amount Of Money You Need

Before researching different lenders, it's crucial to determine the exact amount you'll need to pay off your existing loan free and clear. Be sure to speak with your current lender to guarantee that you will not be charged prepayment fees that cost more than the money you would save from refinancing.

Know Your Credit Score

Check your credit report and score before you consider refinancing. If you are in a better position, you must qualify for a lower rate than your current loan. Refinancing will only be worth it if your interest rate is significantly lower.

To get your credit history for free, you can start with your financial institution or credit card provider. They could provide you with the information. Also, each credit bureau will give you an annual free credit report.

As you shop around for your new loan, see if potential lenders perform a hard or soft credit check when giving you a quote. The hard credit check will negatively affect your score in the short term.

Talk To Your Current Lender

Your current lender is an excellent place to start during your research process. If you have a positive relationship with them, they may be willing to offer a special deal than your current loan to keep your business. They could also get you prequalified without a credit inquiry.

Shop For Rates

Research and compare repayment terms and rates from various personal loan lenders before refinance. Shopping around online is essential because rates and terms vary between lenders. If you end up paying more for your new loan with additional fees or extending the length of payments, the lower interest rate will not save you money.

Even if you're looking for lower monthly payments, it will cost you more over time to extend the maturity of your new loan past your old one.

Apply For Your New Loan

When you've found a lender that suits your needs, you submit your application and provide any required documents. Standard information will be paystubs, W2s, social security numbers, and bank statements.

Remember that your requirements for getting quotes from lenders differ from the formal application. You must submit a formal refinancing application to undergo the loan underwriting process and receive your funds officially.

Make Your Payments

Once you receive your new funds, you or your lender will pay off your existing loan. If you can pay off the old loan yourself, ensure you pay it off as soon as possible to avoid fees, interest, or double loan payments. Receiving your loan funds also begins your new loan repayment period. Your new monthly payments will start with your payment amount, interest rate, and new timeline. Keep your account in good standing and make your payments on time.

When Is the Best Time for Personal Loan Refinancing?

Saving money is the primary goal of refinancing a personal loan. Here are the reasons why it makes sense:

Your Credit Score Improves

To get a lower interest, you need to improve your credit score by making on-time payments, paying down balances, and avoiding unnecessary debt. If you check your score and it has increased since you received your loan, this is an excellent reason to begin the refinancing process.

Your Wage Decreased

If your income has decreased or you lost your job, you'll want to lower your monthly payment to an affordable amount. You can refinance your loan for a longer term. It may not save you money in the long term, but it avoids defaulting on your loan.

Your Loan Rate Has Variable APR

Not all Annual Percentage Rates (APRs) are equal. A personal loan with a variable APR makes it challenging to budget monthly payments. It's also possible that your rate is trending upward and costing you more money. You refinance to a fixed rate to keep your monthly payments predictable.

You Can Afford Higher Monthly Payments

Sometimes, you can afford a larger payment. You have the option to refinance into a shorter loan term. By doing so, you will significantly reduce the total amount of interest you pay over the life of the loan, leading to considerable long-term savings.

Your Loan Has a Balloon Payment

If your loan includes a balloon payment, which requires you to make a significantly larger payment than your regular monthly amount at the end of your loan term. Personal loan refinancing ahead of time can prevent you from paying that balloon payment.

You Can Afford Refinance Fees

When you refinance your loan, you can incur specific fees, such as application fees or origination fees. Your current lender may charge you a prepayment penalty if you pay the loan off early. Before you refinance, your new loan must be less expensive after factoring in costs.

Origination Fee Example

The origination fee for a personal loan is usually deducted from the loan proceeds. For instance, if you are approved for a $10,000 loan and the lender imposes a 6% origination fee, you will receive only $9,400. This is because 6% of $10,000 amounts to $600, which is subtracted from the total loan amount.

When Is It a Bad Idea to Refinance a Personal Loan?

You should also consider these circumstances in which it may not make sense to refinance your current loan:

Current Loan Has A Low Balance

If you've paid off most of your original loan, origination fees on your new loan could offset the benefit of refinancing if your current loan has less than 12 to 18 months of payments.

Interest Rates Are Higher

Interest rates rise and fall. If they have increased since you were approved for your original loans, it might be impossible to get a lower rate even if your credit score has improved.

Planning For A Mortgage Soon

If you're getting a large loan, such as a mortgage, in the next 6 to 12 months, applying for any credit could be better-advised. Your credit score drops after the approval of new credit. Avoid submitting any new application to give you the best scores when applying for a mortgage.

Will Refinancing Hurt My Credit?

You may see a dip in your credit score because you're paying off a loan and getting a new one. Here are some reasons this could happen:

Adding New Accounts

Suppose you've recently applied for or taken out other credit lines or loans. Your credit scores will lower. Credit bureaus consider several new accounts to be a more significant risk.

Closing An Old Account

After refinancing, your original loan will be closed. Some credit scoring systems consider paying off your debt with a loan as unfavorable in ways that car loans or mortgages are not. The average age of your accounts is also considered on your credit reports. Some credit scoring models will consider something other than your old loan on that average. FICO® credit scores use 15% of their score for the length of your credit history.

Hard Credit Checks

When applying for a refinance loan, your lender will perform a hard inquiry to check your credit scores and history. Your credit scores could see a slight drop from this inquiry. When searching for the most favorable interest rate on a personal loan, it’s recognized by major credit bureaus and FICO that you may have several credit inquiries. To accommodate this, multiple inquiries for the same credit type are treated as one if they fall within a designated timeframe. While older FICO scoring models combine inquiries made within a two-week period, the latest FICO score allows consumers a generous 45 days to explore and secure the best rates and terms.

Pros and Cons of Personal Loan Refinancing

There are positives and negatives when refinancing your loan. It's up to you to decide if one outweighs the other. Here's what you need to know.

Advantages Of A Personal Loan Refinance

Your goals will determine the advantages of refinancing, but they generally include reducing the loan cost and getting a lower interest rate. Consider these advantages and discover if refinancing is right for you:

Payoff your loan faster

If you can afford to make higher monthly payments to get out of debt more quickly, you can refinance for a shorter loan term. It also reduces the amount of interest you pay over time.

Predictable payments

If you switch from a variable to a fixed rate loan, you'll know the payment amounts and the repayment term length to help you budget.

More extended repayment period

If you have difficulty paying your loan on time, refinancing with a lengthier term will reduce your monthly payments and help your finances more manageable.

Lower interest rate

If you've improved your credit score or interest rates have dropped, you could save money.

Disadvantages Of Refinancing A Personal Loan

Only some people need to refinance their loan. Before you commit to refinancing, you need to consider these drawbacks:

Higher interest costs

Will extending your loan increase interest costs over time? If you are struggling financially, it makes sense to lower your payments. But remember that reducing your monthly payment and extending your loan term will cost you more money.

Prepayment penalties and extra fees

Always read the fine print when looking to refinance. Check the terms of your current loan and determine if you will be penalized for paying it off early. Also, read the terms of your potential new loan to see if processing or the charges wipe out any money you could save with refinancing.

Is Refinancing Right for Your Situation?

If you're debating refinancing your loan, you must compare the pros and cons. Determine if refinancing saves money, decreases monthly payments, or both. If you benefit from refinancing, check your credit scores, research if there are any fees, and check interest rate options from different lenders and how this decision will affect your credit score.