Refinancing your personal loan is a great tactic to manage financial change. Whether you’re making the shift from a two-income to a one-income household, adding a significant expense, paying off credit card debt or sending children off to college, you may need to adjust your personal loan payments to be more affordable. Consider these scenarios:
Blake took out a fixed-rate personal loan for medical bills a few years ago when interest rates were high. However, personal loan rates have dropped significantly this year and Blake wants to know if he can take advantage of the lowered interest rates.
Reid took out a fixed-rate personal loan to help consolidate her credit card debt last year. At that time she had a stable income, so she agreed to a debt consolidation loan with a short repayment term and large monthly payments. Her circumstances have changed since then and she can no longer afford the payments on her loan. She wants to lengthen the repayment period so she can lower her monthly payment.
Both of them likely have the same question: can you refinance a personal loan?
The answer: absolutely! You can refinance your personal loan with the same lender or a new lender.
Blake and Reid illustrate the two primary reasons people apply for loan refinancing – lowered interest rates and a longer repayment term.
Do you relate to either of them? Refinancing a loan is a great way to adjust your financial situation, but there are a few things you’ll need to know before you dive in and apply. So what exactly is personal loan refinancing and is it good to refinance a personal loan?
What Does It Mean To Refinance a Personal Loan?
Refinancing a loan means applying for a new loan either with the same lender or a new lender. You then use that new loan to pay off the old one, and make loan payments to the new loan from now on. Either your new lender will do a balance transfer to pay off your old loan amount or it will be up to you to repay the original lender. The new loan will then give you a new annual percentage rate (APR) and repayment schedule.
When Should You Refinance a Personal Loan?
It may make sense to refinance your personal loan if your circumstances have changed, such as an altered income or better credit score. As you read ahead, ask yourself if any of these items apply to you and if they resonate as what you’d like to have in your newly refinanced personal loan.
- Income has changed: If your monthly income decreased significantly, you probably want to make your payments smaller to keep them affordable.
- Better credit score: If you have a significantly better credit score than when you first applied, you may qualify for a lower interest rate or a longer repayment term.
- Skip the balloon payment: If your personal loan has a balloon payment (lump sum due at the end of the loan term), you may want to consider refinancing into a personal loan that spreads that payment out over a longer period.
- Switch your rate type: If you have a variable-rate loan, you may want to move to a fixed-rate loan so your interest rate stays the same throughout the loan term. Or, if the fixed-interest rate you’re currently paying is higher than average, you could check to see if switching to a variable-rate loan would provide you with a lower interest rate.
How To Refinance a Personal Loan
If any of the above applies to you, it may be time to consider a refinance loan. Refinancing a personal loan requires five steps. While the process is similar to applying for your initial personal loan, it has a few key differences. We’ve outlined the five steps for you:
1. Check your credit score
Before you start looking for personal loan refinancing options, it’s wise to understand your own financial situation. Check your credit score to see how it compares to when you first took out your loan. See if what you qualify for is different from what you’re currently paying for. (Many credit cards give you a free check with your statement each month).
If you want to see your entire credit report, you’re entitled to a free credit report from each of the three credit bureaus each year.
2. Find refinance options
Personal loan refinance options are all around. You should consider your bank, local credit union and online lenders.
You can sometimes refinance your loan with the same lender. Ask your lender if you can negotiate your personal loan with them. Be clear which terms you want to adjust and listen to what they can do.
However, before you sign anything, it’s worth comparing other lenders’ rates and terms to see if you can get a better loan elsewhere. Don’t just stick with your current lender without finding out about other personal loan refinance options.
3. Compare different lenders (and get prequalified)
Unlike when you were applying for your initial loan, you already have a baseline personal loan interest rate and fees to measure against. For refinancing to be financially wise, you’ll want to find a loan option with better terms than your old loan.
Compare different lenders’ personal loan interest rates, fees and other terms against each other, but also compare them to your old loan. Because lenders often advertise their best rates, but not standard rates for different credit scores, you may need to get prequalified to get an accurate interest rate for you.
You can always call a lenders’ customer service line to get more information on their personal loan refinancing options.
4. Apply for a new personal loan
Once you have a loan offer you like, you can finally apply. Applying for a refinance loan should look very similar to when you applied for your old loan. Gather any financial information you may need, fill and send out the application and wait to be approved.
5. Wrap up your old loan
Don’t get so excited about your new loan that you forget to close the door on your old one. Once you’ve been approved and paid off the old debt, be sure to double check that the loan amount is 100% paid off and the statement balance is zero. Consider keeping the account open with a zero balance because it will help your credit score.
You also don’t want your credit report to take a hit because you forgot to pay off the balance of your previous loan.
Pros and Cons of Refinancing a Personal Loan
Before committing to refinancing your personal loan, there are a few pros and cons you should know. Refinancing your loan can help your financial situation, but also may have a negative impact on your credit score, or make you pay even more in interest over time. Let’s take a closer look at the pros and cons of refinancing.
What are some advantages of refinancing?
Refinancing your personal loan has a lot of perks, or pros. Let’s dig into a few ways refinancing will save you money and help your current situation.
Lower interest rates
If interest rates have dropped significantly since you first got your loan or your credit score has increased, you may be paying more in interest than you would be if you refinanced. In that case, refinancing will help you get a lower interest rate and you will pay less in interest over the life of your loan.
Longer repayment term
If your original personal loan term was on the short side and you’d like to spread it out over a longer period of time, you can do that.
Smaller monthly payments
If your monthly payments are too big for your budget, then refinancing to a longer repayment period can help make them more affordable.
What are some disadvantages of refinancing?
Depending on what you’re refinancing for, there are a few cons that won’t apply to every situation. Refinancing isn’t always the best option. So, you should know the cons and how they may affect your financial health, both short- and long-term.
Temporary harm to your credit score
Refinancing your loan has the potential to harm your credit score in three different ways. However, the harm is temporary and, unless you’re planning to apply for other financing or make any large purchases (real estate, car, etc.) in the near future, it could be an acceptable price to pay.
How does refinancing a loan affect your credit score?
- Hard credit check: Because your lender will do a hard credit check on you before approving your new loan refinance, your credit score may drop slightly.
- Opening a new account: By taking on a new loan, you’re taking on new debt, which causes your credit score to rise.
- Paying off your old loan: You’d think that paying off your current loan would be a good thing, but it actually could hurt your credit score.
Potential to pay more interest
If you’re refinancing your personal loan for a longer loan term, you may end up paying far more interest than your old loan. Even if the personal loan rate is lower than your old one, the longer lifespan of your loan means the interest will have more time to accumulate.
New fees
While a fee shouldn’t stop you from refinancing, it should give you pause. Take time to compare the cost of the refinance (fees plus interest over the entire life of the loan) to what you’re paying for your old loan. You’ll want to read the terms and conditions of the loans and definitely factor them into the cost of a new loan when you’re comparing lenders.
Watch out for two primary fees when it comes to refinancing loans: the origination fee and the prepayment fee.
- Origination fee: Many lenders charge an origination fee to take out a loan.
- Prepayment fee: Some loans charge a prepayment fee for paying off your loan early.
Is Refinancing a Personal Loan Right for Me?
Refinancing your personal loan is a great way to change the terms of your loan or take advantage of having a better credit score. It’s similar to applying for an unsecured personal loan, so you’ll already have experience with the process. If any of the primary reasons to get a loan refinance resonate with you, it may be time to look into it.