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How and When To Refinance a Personal Loan

TLDR

What You Need To Know

  • Personal loans can be refinanced much like other loans. Depending on your financial and credit profile, refinancing a personal loan can save you money
  • As long as you’ve started making payments on your personal loan, you can refinance it at any time
  • Refinancing your personal loan can cause your credit score to drop slightly at first. But the impact decreases when you make monthly payments on time and in full

Contents

Personal loans can be a helpful way to finance a whole host of things, from a home improvement project to a wedding or even emergency medical bills. If you currently have a personal loan, you may be wondering when and if you can refinance the loan and if refinancing might be a good move. 

Personal loans can be refinanced much like other loans, and depending on your financial and credit profile, refinancing a personal loan can save you money. We’ll give you the scoop on what it means to refinance a personal loan and when refinancing your personal loan might be a good idea for you.

What Does It Mean To Refinance a Personal Loan?

When you refinance a loan, you replace your current loan with a new loan. But refinancing may be a bit of a misleading term because when you refinance, you don’t tinker with your existing loan – you get a brand-new loan with brand-new terms. 

The general goal when you refinance is to save money on interest. But you can change other loan terms too, like the repayment period or the monthly payment. 

Technically, there’s no waiting period to refinance. As long as you’ve started making payments on your personal loan, you can refinance it at any time. 

But before you decide to refinance, you should carefully consider whether the new interest rate and loan terms will outweigh the upfront costs to refinance, such as the origination fee. 

And you should keep an eye on potential interest rate hikes. If interest rates are going up, you may want to wait or refinance your loan sooner rather than later.

Reasons Why You Should Refinance a Personal Loan

There are plenty of reasons to refinance a personal loan. If issues with your income have made it difficult to make on-time payments, a refinance can help by reducing your monthly payment. If your credit score has increased since you took out the loan, you may be able to save money by refinancing and qualifying for a lower interest rate and better terms.

Here are some of the most common reasons to refinance a personal loan:

Pay your loan off faster

Let’s say you’re in a better financial position today than you were when you took out your personal loan and can afford an increase in your monthly payments. If you refinance to a shorter repayment term, you can pay off your debt faster – getting you even closer to that debt-free lifestyle you may or may not have been contemplating. And, with a shortened loan repayment period, you could save a bundle in interest.

Get a new interest rate

If interest rates have dropped or your credit score has improved, loan refinancing could score you a better interest rate. 

Refinancing with an improved credit score could dramatically lower the loan’s interest rate. We’re talking lower monthly payments and more money in your pocket. 

Refinancing can also change the type of interest rate you have. Most personal loans have fixed rates, but some have variable rates. Variable rates can be difficult to manage because they can change based on market conditions. Your interest rate could go down, but it could also go up – way up. Every change in rates will affect your monthly payments, which will impact your budget.

If your personal loan has a variable interest rate, you could refinance the loan and lock in a low, fixed rate. This will guard you against any future rate increases and make your monthly payments a whole lot more predictable.

Skip a balloon payment

Some personal loans have monthly payments and a balloon payment (read: a larger than average lump-sum payment) at the end of the loan’s repayment term. The balloon payment could be twice as much as your monthly payment or larger.

If you refinance your personal loan, you may be able to eliminate the balloon payment and opt for more favorable loan terms. 

Does Refinancing a Personal Loan Hurt Your Credit?

Refinancing your personal loan can cause your credit score to drop slightly at first. But the impact decreases when you make monthly payments on time and in full. Why? Because that’s the power of on-time payments. They improve your payment history, which makes up 35% of your credit score.[1]

Here are some ways refinancing your personal loan can negatively affect your credit score:

Hard credit check for the new loan

When you refinance your personal loan, or just about anytime you apply for a new loan or credit, a lender will perform a hard credit check (also called a hard credit pull or a hard credit inquiry). The inquiry will cause your credit score to experience a slight, short-term dip. 

The dip is temporary and should be resolved in 1 – 12 months.[2]

FYI: Your score might bounce back even faster if you make consistent on-time payments. 

So, you can think of the slight, short-lived drop in your credit score as a small setback when you compare it to the money refinancing could potentially save you.  

Closing an old account

The age of your credit history is a factor in calculating your credit score. In the FICO® credit scoring model, it accounts for 15% of your credit score.[1] If your personal loan is the credit account you’ve had the longest, your credit history will be shortened if you refinance.

Opening a new credit account

New credit accounts for 10% of your FICO® score.[1] Opening a new account can cause your credit score to slip (temporarily). It’s important to avoid opening several new accounts at once because it will only multiply the impact on your score. 

What Are the Risks and Benefits of Refinancing a Personal Loan?

When you’re deciding whether to refinance your personal loan, it’s helpful to cycle through the pros and cons. We’ve laid out the major benefits and drawbacks of refinancing your personal loan.

PROS of Refinancing a Personal Loan👍

Lower Annual Percentage Rate (APR)

You can get a lower APR (a loan’s interest rate and fees), which will reduce the amount of interest you pay over the life of the loan, saving you money.

Debt consolidation

Because you can borrow more money than your loan amount, if you have a lot of credit card debt or have another higher-interest loan, you can use the extra money to pay it off. You may even be able to consolidate your credit card debt by transferring it to another card with a low APR and paying it off even faster.

Reduce overall monthly bills

Refinancing to a lower interest rate or a longer repayment period will lower your monthly loan payment.

CONS of Refinancing a Personal Loan👎

New origination fees

Refinancing your personal loan will probably require an origination fee that’s 1% – 10% of the loan amount. This can add significantly to the loan’s cost, especially if you’re borrowing more than you need to refinance.

Credit score hit

Your credit score will probably take a slight dip when you apply to refinance.

Potential penalties for early payoff

Your lender may charge you a prepayment fee when you refinance your personal loan.

What Are the Steps to Refinancing Your Personal Loan?

Refinancing your personal loan will look very similar to applying for a personal loan. There are six main steps:

  1. Gather information

First, get the facts. Figure out how much you still owe and what fees you’d need to pay to refinance. Review your credit score to help you gauge if your credit has improved since you took out the loan. And whether you’re refinancing with your current lender or a different one, don’t forget to check if your current lender will charge a prepayment fee for refinancing.

  1. Get prequalified for a personal loan

Ask your lender to prequalify you for the new loan. You’ll be able to see how much you can take out (especially if you want to borrow more money than the loan amount) and what the loan terms will be.

  1. Shop around for the best rates and terms

Talk to a few lenders. Find the one with the best rates and terms. Decide whether you want to work with an online lender or a traditional lender, like a bank or credit union. When you reach out to lenders, make sure and ask them about their fees, like the loan origination fee.

  1. Apply for your new personal loan

Once you’ve found a lender and a loan you like, you’ll fill out your personal loan application. Collect the paperwork and information you’ll need, like your Social Security number and relevant income and credit information. 

  1. Close out the original loan

Remember, refinancing your personal loan means closing out the original loan and getting a new loan. If you use a different lender for the refinance, your new lender may communicate directly with the current lender to pay off that debt. The new lender might, however, give you a disbursement check for you to pay off the loan.

  1. Manage your monthly payments

We can’t stress this enough: make your payments on time and in full. This will boost your credit score as you pay off your personal loan. Bonus: You’ll avoid having to pay late payment fees and incurring additional interest.

When Should You Refinance Your Personal Loan?

Figuring out when to refinance your personal loan will take a bit of thought – but don’t think too long. Interest rates are expected to rise (several times) this year. If you’ve got refinancing on the brain, you’ll want to lock in your rate before another rate increase or wait until interest rates slide back down.

Remember, the point of refinancing your loan is to save money or make your payment schedule easier to manage. 

Find Lending Options That Meet Your Refinancing Goals

Your financial circumstances should dictate whether refinancing your personal loan is right for you and when is the right time to refinance. A trusted lender can help you come to a decision that takes your finances and your financial goals into consideration.

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  1. FICO®. “What’s in my FICO® Scores?” Retrieved April 2022 from https://www.myfico.com/credit-education/whats-in-your-credit-score

  2. Experian™. “Can a Personal Loan Hurt My Credit Score?” Retrieved April 2022 from https://www.experian.com/blogs/ask-experian/can-personal-loan-hurt-credit-score/

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In Case You Missed It

  1. If your credit score has increased since you first took out a personal loan, you may be able to save money by refinancing to a lower interest rate

  2. Some personal loans have variable interest rates. By refinancing, you could lock in a low, fixed rate

  3. For personal loans with balloon payments, refinancing may allow you to eliminate the balloon payment and get more favorable loan terms

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