Refinance your personal loan to replace it with a loan that has a lower interest rate and a revised repayment schedule. If interest rates are dropping or are lower than current rates, or if your repayment terms need to be extended, refinancing may be an option.
Refinances offer lower interest rates, which means you will pay less overall on your personal loan. A longer loan term can be refinanced to lower monthly payments. Due to interest charges, you will most likely pay more towards the loan overall if you extend the repayment period.
What is meant by refinancing a personal loan?
Refinance a personal loan involves applying for a loan with the same lender as before. Then, you will use the funds to repay your existing loan. After the process is completed, you will make payments on your new loan at a new interest rate.
Refinance of a loan can be done for many reasons. However, the ideal outcome would be to get a better interest rate.
“Typically, the goal is to reduce your monthly payment or lower your interest rate. Vida Awumey, an ex-vice president and director for policy research at OneMain Financial, says that the new loan could be for a larger amount if the goal is to obtain more money for a specific need.
What is the best way to refinance a personal loan?
If you can save money, refinancing your loan is almost always a good idea. It is possible to save substantial amounts in many situations.
Adam Marlowe is the principal market development officer at Georgia’s Own Credit Union. He says, “For example: If interest rates drop and it is possible to get a lower rate, you might want to refinance.”
These are just a few other instances when it might make sense.
- A higher credit score. Your credit score is one of the best ways you can qualify for a personal loan with a lower interest rate. Refinance is possible if your credit score has improved since you took out your initial loan.
- You may wish to change your rate type. Variable APR personal loans make it difficult to plan your monthly payments. You might also see an upward trend, which could end up costing your business more. Refinancing allows you to switch from a variable-rate to a fixed rate so that you have consistent monthly payments.
- You want to avoid a balloon payment. You should avoid a balloon payment on personal loans. This means that you will have to pay a higher monthly payment than your normal monthly repayments. To avoid this type of personal loan, you can refinance before the due date.
You have a lower income and need to pay less monthly.
- You may want to reduce your monthly loan payments. if you have lost your job or have a lower income. You may be able to refinance your existing loan for a longer repayment period. While this may not be a good option, it could reduce your monthly payment.
- You want to pay off your loan faster. You may be able to afford higher monthly payments if you refinance your loan into a shorter term. You will save money on interest by paying off your loan in a shorter time.
- The fees are affordable. Refinance loans can be subject to fees such as application fees and origination fees. If you repay your loan early, your current lender might charge a prepayment fee. Consider whether refinancing is still financially viable after taking into account fees before applying for a loan.
When does it make sense to refinance a personal loan?
In some cases, a personal loan is not worth the effort and time it takes. These are the situations when refinancing might not be the best option:
If your loan balance is low: Refinances are not recommended if you don’t owe a lot on your current loan. Some loans have origination fees. Do not pay more fees. Instead, pay off the loan balance and your original loan faster.
If your interest rate is higher: If you aren’t getting a better interest rate by refinancing, you might want to reconsider whether you should move forward. If you are unable to afford the monthly payments or need to increase the repayment timeframe to lower them, this may be a good option.
The repayment time is nearly over: Refinancing your loan will extend its duration if you are nearing the end of your repayment schedule. This means that you’ll pay more in interest fees overall.
How to refinance a personal loan
These steps will help you refinance your loan. start with the following steps.
1. Calculate how much money is needed
Refinance a loan is essentially paying off an existing loan by taking out a new loan with different terms. Before you start looking for quotes, calculate the amount that is required to repay your existing loan. You should also check if the original lender has prepayment penalties. These could outweigh any benefits from refinancing.
It is crucial to know your loan payoff amount in order to determine the amount of loan refinance that will be required to clear your original loan.
Get involved: Log in to your personal loan account, or call your lender to get your outstanding payout balance and learn more about prepayment fees.
2. Check your credit score and credit report
You will need to review your credit score and credit history before refinancing your loan. This is an essential step in determining if you are eligible for a lower interest rate than you currently pay. Refinance may not be worthwhile if the new interest rate doesn’t seem to be significantly lower.
Marlowe states that while most lenders will offer the best rate if you don’t have A+ credit, it may not be the rate that you are eligible for. Check to see if your financial institution or credit card issuer offers this free of charge to customers to improve your credit score.
A free credit report can be requested from each of the three credit bureaus: Equifax, Experian, and TransUnion. However, weekly reports are available for free until April 20, 2022.
When you are shopping for a loan, find out whether the lenders will do a hard pull or a soft pull to determine your credit score. Hard credit scores will negatively impact your score in the short term, so it’s important to compare rates from lenders who only use a soft pull. This is prequalification.
Get involved: Request your free credit report from Equifax, Experian, or TransUnion.
3. Find rates and terms from banks and online lenders
Refinancing a personal loan is a matter of research. Before refinancing, you should compare rates and terms from different lenders. It is important to shop around as the terms and interest rates offered by different lenders can vary. A new loan with a lower rate of interest is not necessarily better, especially if it comes with additional fees or if it’s being extended unnecessarily.
Jeff Wood, CPA, and Partner at Lift Financial say that refinancing a loan can result in additional fees and charges to the loan terms. To replace your current loan, you may be subject to a prepayment penalty. These factors should be taken into consideration to decide if refinancing is a good idea, both financially and personally.
It may not be a good idea to extend the maturity date of your new loan beyond the original loan’s maturity. You could pay more interest over a longer period of time, even if your interest rate is lower.
Get involved: Compare the features of at minimum three personal loans refinance options. A personal loan calculator will help you determine the total cost of each loan.
4. Talk to your current lender
During the research, don’t forget about your existing lender. You may find a better deal with your current lender to help you keep your business afloat.
Awumey states, “You already have a relationship with that company.” Your lender will evaluate your financial situation and determine if you are eligible for a loan. Many lenders will allow you to see if your credit score is acceptable for a loan.
Get involved: Contact your current lender to tell them that you are considering refinance of a personal loan. Ask your lender if you are eligible and what the rate and terms they would be willing to offer.
5. Apply for the loan
Once you have settled on the lender you like best, submit your application and provide any verification required — this could include your Social Security Number, pay stubs, or tax documents.
The loan comparison process discussed earlier is not the same as a formal refinance application. You will need to submit a formal request in order to move forward with a loan proposal, go through the loan underwriting process, and get funding from your lender.
Get involved: Before you sign the loan agreement, read the fine print. Take note of your payment plan and any fees, as well as prepayment penalties. Accept the loan terms if you are satisfied. Usually, funds will be available within a few days.
6. Start making monthly payments on your loan
You’ll pay off your existing loan with the funds you get from your new loan. You should do this as soon as you can to avoid paying double the loan amount or accruing excessive interest.
You also get into the repayment period for your new loan when you receive your loan funds. With your new interest rate and repayment schedule, you’ll immediately begin to make monthly payments. Your account will remain in good standing by making timely, regular payments.
Get involved: Setup auto-pay to your refinance loan so that you don’t miss a single payment.
How refinancing personal loans can affect your credit score
Refinances are subject to credit checks. Although this can affect your credit score, it should not be permanent. This is especially true if your new loan will allow you to practice good financial habits.
Awumey states that credit inquiries and new accounts can have a negative impact on your credit score in the near term. However, making timely payments on a loan will improve your credit score long-term.
If you are looking to purchase a car or move into an apartment, a small amount of interest could be a problem. Refinancing your loan at the wrong moment could make it harder to find housing or a car.
Advantages of refinancing a personal loan
Refinancing a personal loan can have many benefits. They may include a lower interest rate or a reduction in the total cost of the loan.
A better interest rate: If rates have fallen or your credit score has improved, you may be able to make money on interest.
Quicker loan repayment: If your monthly payments are higher than you would like and you need to pay off your debt quicker, you may be able to refinance your personal loan for a shorter term. You’ll also pay less interest overall.
Extend your loan repayment terms: If you have difficulty paying your loans on time, extending your terms can make it easier to manage your monthly bills.
Payment stability: Refinance can offer payment stability for those who are switching from a variable to a fixed-rate mortgage.
Disadvantages of refinancing a personal loan
Refinance is not for everyone. Be aware of the following disadvantages before you commit to a refinance:
- Additional fees: When you take out a loan, there might be additional fees that you have to pay. This can reduce the savings you are trying to make.
- Prepayment penalties: Some loans have a prepayment penalty if you don’t pay off the loan balance before the term ends. Refinance requires you to pay off your existing loan and then replace it with another. It is best to review the terms of your current loan in order to see if you will be penalized for early repayment.
- Higher interest rates: Usually, extending a loan term results in higher interest costs over the life of the loan. Refinance might be an option if you are trying to reduce your monthly payment due to financial difficulties. Understanding that a lower monthly payment won’t necessarily save you money over the long term is important.
- Credit score impact: Refinances count as a new loan inquiry and can affect your credit score even though their effect is temporary.
- Application and research time: It takes time to search for lenders, compares rates, and submit applications. Refinancing is not recommended if your loan is nearing its end.
Refinancing a personal loan is a smart financial move. These are the first questions to ask: Are you eligible for a lower interest? Lower monthly payments More favorable terms
Refinancing has its pros and cons. There are prepayment penalties, extra fees, and higher interest costs. After you have done your research and spoken with several lenders, you will be able to decide if refinancing is a good idea.