How to Refinance a Personal Loan

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Points of Interest

Refinancing a personal loan can offer long-term savings or lower payments if the loan conditions are right and better rates are available.

A personal loan is a great financial tool to help you out when you need money for any number of different reasons. What you may not know, though, is that you may be able to change your repayment terms and either save money on interest or lower your payments through a process called refinancing. Now, you may be wondering things like, “What is refinancing a loan?” or “What happens when you refinance a loan?” The answers to these questions are simple and may give you the information you need to save or lower your payments.

When to refinance a personal loan

There are two main situations when it may be the right time to refinance a personal loan. First, if your financial situation has changed or interest rates have dropped, you may be able to refinance and save significantly on future interest costs. Second, if you’re having trouble keeping up with your payments, you may be able to refinance out to a longer term. This will cost you more money in the long run, but you’ll be able to lower your monthly payments and avoid defaulting on your personal loan.

How to refinance a personal loan

The term “refinancing” is just a fancy financial term that means to take out a second loan to pay off your first loan. You take the money from the second loan and completely pay off your first loan. After that, you only owe money on the second loan.

To do this, you’ll need to shop outside lenders (a company other than the one you currently have your loan with). There are rare occasions where you can refinance with the same company, but most likely, you will be looking at another lender.

Tip: You may be able to refinance with your existing loan company. It never hurts to check to see what rates and options the company is willing to offer you. 

Once you’ve found lenders offering personal loan refinancing, reach out to a lending officer to discuss your situation. You will need all of the details on your current loan, income, current assets and any other financial documents you needed or were given when you applied for the initial loan.

From there, find the lender that is offering you the loan terms you want. Secure that loan and use the money to pay off your first loan. After that, you only have to make payments on your second personal loan.

Pros and cons of refinancing a personal loan

Refinancing personal loans can do a lot of good for some people, but it’s not always the right fit. The answer to whether you should do it depends on the terms of your loan, your financial situation, what is currently available on the market and what your financial goals are.

Pros

  • Refinancing may help you to lower your interest rate and save significantly over the life of the loan. If you have an extremely high rate and rates have dropped, or your credit score improved, this pro may be even more significant.
  • For some, refinancing can help extend the repayment terms and lower your monthly payment obligation. While this may cost you more in the long run, it can protect your credit score by keeping you out of default.
  • You may have the option to consolidate multiple forms of debt or personal loans into one single monthly payment.

Cons

  • You may be charged new fees that could negate the savings. Additionally, you may not have the money for the fees if they’re required upfront.
  • It could have a short-term negative effect on your credit, as it will show a closed credit account, lower the age of your credit profile and put a hard inquiry on your report. The exact effects will depend on the loan terms and which credit reporting bureau you are looking at.
  • If you are extending the length of your loan to lower your payments, it will cost you more money in the long run.

When not to refinance a personal loan

There are a few situations where refinancing might not be the right fit. First, if you aren’t able to save or get the repayment terms you want, there’s no point in refinancing. Second, if the fees are too high and erode all the savings, it won’t be a good fit.

Additionally, if you are looking to make any other lending decisions soon, you may want to avoid refinancing. It could have a short-term negative effect on your credit score. If the loan is for significantly more money (even through interest from extending the loan), these effects could follow you for a longer time.

Tip: While refinancing a personal loan may have a short-term impact on your credit score, the long-term benefits of saving money and staying up on your payments are much more beneficial. 

Things to be on the lookout for with lenders

Not all lenders offer the ability to refinance. While refinancing is quite popular with personal loans, you’ll want to make sure to specifically check for that option when shopping for lenders. Your lender won’t be able to stop you from refinancing with another company, but you may be subject to prepayment penalties. Before shopping around, check the terms on your loan to see if you are subject to prepayment penalties. This will be an important consideration in the decision-making process.

Remember, you should look at refinancing lenders with the same scrutiny that you used when taking out your first loan. Look at reputations, repayment terms, fees, prepayment penalties, additional perks and anything else that is important to you.

The final word

Refinancing personal loans is a popular move, especially when interest rates are low, or your credit profile has improved. By refinancing in these situations, you stand to save a lot of money over the life of the loan. Refinancing can also help out when you’re struggling to stay up on payments and need to see a lower monthly obligation. Ultimately, whether or not the move is right for you and your loans will come down to a case-by-case basis.

FAQ

Does refinancing a personal loan hurt your credit?

Refinancing a personal loan can have a short-term (and sometimes a long-term) effect on your credit score. The closing of your initial loan will register as a closed account. The opening of your new account will come with a hard inquiry on your credit, shorter account age and possibly a higher outstanding balance if you aim to lower your payments. Still, refinancing to save money or stay up on your payments is often the optimal move.

When should you refinance a loan?

Refinancing a personal loan should be done when interest rates drop, your credit profile improves or you need to see the relief on your monthly payments to avoid default.

What happens when you refinance a loan?

When you refinance a personal loan, you take out a brand new loan. The money from that new loan is used to fully pay off and close out your old loan. From then on, you only make payments on the new loan, as it is the only one still active.

Is it better to refinance or get a personal loan?

Refinancing is something that only happens after you have already taken out a loan. If you are currently looking for money and have no outstanding loans, your only option is to get a personal loan. If you do have outstanding loans and need money to pay them, you may be able to take out an additional personal loan to catch up on payments. When you take out a second personal loan to pay off the entire balance of your first loan, that is refinancing.

Jason Lee

Personal Finance Contributor

Jason Lee is a seasoned copywriter with a passion for writing about banking, tech, personal growth, and personal finance. As a business owner, relationship strategist, and officer in the U.S. military, Jason enjoys sharing his unique knowledge base and skill set with the rest of the world.