How to Refinance a Personal Loan
Updated: March 6, 2024
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Refinancing a personal loan involves replacing an existing loan with a new one, often to secure better terms or a lower interest rate. This financial move can lead to significant savings, reduce monthly payments or adjust the loan's term to better suit one's financial situation.
Anyone can refinance a personal loan provided they meet the lender's requirements. However, it's helpful to understand how it works and its advantages and disadvantages to determine if this option aligns with your financial goals and circumstances.
What Does It Mean to Refinance a Personal Loan?
Refinancing a personal loan is a financial strategy where you replace your current loan with a new one, often with different terms. This process involves taking out a new loan and using it to pay off the existing one. The new loan typically comes with terms that are more favorable to your current financial situation, be it a lower interest rate, a different loan term or both.
By refinancing your personal loan, you can make your debt easier to manage. It can help in various ways, such as reducing your monthly payments, which can be particularly beneficial if your financial situation has changed since you first took out the loan. For example, if interest rates have dropped or your credit score has improved, you may qualify for a lower rate, which can reduce the amount you pay over the life of the loan.
Additionally, refinancing can adjust your loan's term length. If you extend the duration of your loan, your monthly payments might decrease, making them more manageable in your current budget. However, this might lead to a higher total interest cost over time.
You can refinance a personal loan through any consumer lender that offers standard loans. That means you can refinance your loan with the same lender or consider other lenders, especially if they have better loan terms. However, it's best to check with the lender to ensure you qualify for refinancing.
Pros and Cons of Refinancing a Personal Loan
Before refinancing a personal loan, weigh its advantages and disadvantages to understand how it aligns with your financial goals and whether it's the right move for your situation.
Advantages of Refinancing a Personal Loan
Disadvantages of Refinancing a Personal Loan
When to Refinance a Personal Loan
Refinancing a personal loan can be wise if you're seeking lower interest rates or more favorable loan terms. That said, it's helpful to evaluate certain factors to determine whether refinancing makes the most financial sense for your current situation.
When Refinancing a Personal Loan Is a Good Idea
When Refinancing a Personal Loan Is Not a Good Idea
How to Refinance a Personal Loan
If you are wondering how to refinance a personal loan from any lender, you can follow the standard procedure to begin this journey.
Determine the Amount You Need
Assess the total amount you need to borrow to pay off your existing loan. This includes considering any additional funds you might need on top of your current loan balance, including origination fees and prepayment penalties. Knowing the exact amount helps you choose the right loan and avoid borrowing more than necessary.
Check Your Credit Score
Your credit score plays a significant role in determining the interest rate and terms you'll receive. You can obtain a copy of your credit report from Equifax, Transunion or Experian. You may also check your report free of charge once per year on the Annual Credit Report website. Make sure to review it for accuracy and understand your credit score. You may qualify for better rates if your score has improved since your original loan.
Explore Lenders
Research various lenders, including banks, credit unions and online lenders. Each lender has different rates, terms and fees, so it's beneficial to explore a wide range to find the best fit for your needs. Consider lenders you've worked with before, as they may offer favorable terms to returning customers.
Get Prequalified
Many lenders offer the option to get prequalified, which gives you an idea of the rates and terms you might receive. Prequalification is typically done online and involves a soft credit check, which won't impact your credit score. This step helps narrow down your options without committing to a specific lender.
Compare Loan Offers
Once you've received prequalification offers, compare the interest rates, terms and fees from different lenders. Pay attention to the total cost over the life of the loan, not just the monthly payment. This comparison will help you find the most cost-effective option.
Submit Loan Application
Complete the loan application process with the chosen lender after selecting the best offer. This will involve providing identification and financial information, including pay stubs and income statements. You will also undergo a hard credit check, which could temporarily affect your credit score. Ensure all information is accurate and complete to avoid delays.
Make Payments on the New Loan
Once your refinancing is approved and you pay off your old loan, start making payments on the new loan. Setting up a budget to accommodate these payments is essential to maintain your financial health. Stay on top of these payments to avoid any negative impact on your credit score. You may consider autopay, if available, to facilitate a more streamlined repayment schedule.
Understand the differences between refinancing a personal loan and debt consolidation:
Refinancing:
- Applies specifically to an existing personal loan. The goal is to get a new loan with more favorable terms to replace the original loan.
- Refinancing aims to keep borrowing the same amount at a lower rate over the same term.
Debt Consolidation:
- Consolidates multiple debts (credit cards, loans, etc.) into one new loan or line of credit and uses the new loan to pay off balances from various sources.
- Consolidation involves taking out an entirely new loan to replace various debts.
- Consolidation may extend term lengths to lower payments.
— Alvin Yam, CFP®
How Refinancing a Personal Loan Affects Credit
When you apply for personal loan refinancing, a credit check is a standard part of the process. This check is a hard inquiry, which can temporarily lower your credit score. Hard inquiries indicate to credit bureaus that you're seeking new credit, which can be interpreted as taking on more financial risk. Each inquiry might reduce your score slightly, as it reflects potential new debt.
However, multiple inquiries for the same type of loan within a certain period can be treated as a single inquiry. Depending on the credit scoring model, this can range from 14 to 45 days. This consolidation is designed to allow you to shop around for the best rates without incurring multiple penalties on your credit score, minimizing the impact of refinancing on your credit health.
FAQ About Personal Loan Refinance
MoneyGeek answered some common questions about refinancing personal loans to help you understand what it entails and how to refinance a personal loan.
Several alternatives to personal loan refinance are available across lenders, including credit cards, home equity loans, peer-to-peer loans, business loans and lines of credit.
Personal loan refinancing types include fixed-rate and adjustable or variable-rate loans. You can choose an ideal type depending on your financial goals.
Depending on your chosen terms, a personal loan refinance may increase or decrease your monthly installments. For instance, if you choose a longer repayment period, you may end up with lower monthly payments.
The same fees charged on original personal loans may also apply to refinancing. These include prepayment penalties, origination fees and late fees.
The duration between approval and receiving your refinancing funds may differ based on the lender. Generally, it may take up to a few days to receive the funds.
Lenders often require documents similar to those of an original personal loan application. These include personal identification, like a Social Security number and financial documents like pay stubs.
There's no definitive rule, but there are some guidelines. You can use online calculators to determine your specific costs and projected savings with a loan refinance. Remember that refinancing too close to the original loan's maturity may not provide enough time to recover refinancing fees through savings. You may also prioritize variable-rate loans for refinancing if rates are projected to rise in the near future.
About Christopher Boston
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